In 2017 the Social Security salary limit increased from $118,500 to $127,200. Social Security is taxed to the Employee and the Employer at a rate of 6.2% up to this cap. Wages over this amount are not subject to this tax.
The cap is just one way that the fund balances the need for income with fairness and return for the people paying into the fund. The others include bend points and annual maximums. These triangulate to create what could be viewed as a ‘Return on Investment’ for the fund participant.
Your PIA is the amount that you would earn at Full Retirement Age and is based upon the highest 35 wage earning years, years with $0 in earnings will count and bring down your average.
Bend Points reduce the amount of your wage that goes into the PIA calculation at three levels of income, the Bend Point changes each year via a calculation that involves dividing the previous year’s average wage (AIME)with the first year of this system (1979).
PIA is reduced for taking the payments early, and increased for delaying them. Delaying social security is still a valid strategy, even with the demise of File and Suspend, but it has changed from a great strategy to a very case by case analysis these days.
Here’s a chart that shows how these factors interplay. I’ve started annual salaries at $5,000 and they run until $150,000. In reality, there is no difference in Social Security taxes here for a salary above the cap of $127,200 and amounts over this are included solely for illustration.
Blue Line (Left Y Axis with X Axis)
The PIA can be seen in Blue, note the Bend Points. These should occur at the following levels of PIA for 2017:
- $0 to $885 * 90% Earning
- $886-$5,336 *32% Earning
- $5,336 and above *15% Earning
But because there is a salary cap of $127,200 the third bend point actually ends at $10,600 and is not open ended. This cap is a bad thing for the Social Security Trust Fund Asset levels, and a good thing for the high earning individual who pays into the fund.
This cap is balanced by another cap. There is an annual maximum payment that an individual may receive as PIA at Full Retirement Age, for 2016 it was capped at $2,639. This amount can be exceed via delaying the receipt of payments, but otherwise is a limit. As such, the blue line for PIA actually shows Five rather than Three bend points.
Orange Line (Left Y Axis with X Axis)
This shows that while the earnings or ‘return’ on your taxes decreases at a rate of five bend points, your taxes paid are constant until $127,200. This is a way to show that the higher earning individual is supporting the broader social system via taxes paid.
Green Line (Right Y Axis with X Axis)
This expounds on the notion of higher earners supporting those with lower income in the form of a Return Ratio. The highest return is shown by a person with a $5,000 annual salary, who would pay $25.83 in monthly social security tax in return for a $375 monthly PIA. This is a 14.516 multiple on the benefit. Whereas at the other side of the scale, the higher earner will get only a 4.0155 multiple.
There’s certainly an active argument about solvency for the Social Security program, and it is clear that the return on investment declines in relation to income, meaning that strategically it may be better to avoid the higher tax brackets where possible, not something that an employee can control, but it is something that the self employed can have power over.