Investing News

The Social Security Cap

The amount of workers’ earnings subject to Social Security taxes is capped each year (called maximum taxable earnings). The federal government increased the Social Security cap significantly for 2021. In 2021, the maximum earnings subject to Social Security taxes is $142,800.

These increases are meant to keep benefits on track with inflation or the pace of rising prices in the economy. As a result of the cap increase, high-income workers will pay a few hundred more dollars in Social Security taxes next year.

Given that Social Security faces significant shortfalls that will make it impossible to pay out future benefits as promised without significant changes, will next year’s cap increase help Social Security last longer? Here is a look at the issues.

Key Takeaways

  • In 2021, the Social Security cap, or the annual earnings on which Social Security payments are calculated, will increase from $137,700 to $142,800.
  • The combined trust funds of Social Security and Disability Insurance (DI) held nearly $3 trillion in 2020 but are projected to run out of money by 2034.
  • However, the Social Security retirement fund will be depleted sooner, in 2033; after that point, only 76% of the scheduled benefits will be paid.
  • Solving the long-term funding problem will probably require higher Social Security taxes, lower benefits, and indexing the retirement age to life expectancy.

The Social Security Cap Increase for 2021

The 2021 Social Security cap increase is a $5,100 increase over 2020. The table below shows the annual increases in the Social Security tax cap for the past ten years.

While the Social Security tax burden appears to hit the self-employed harder than employees, the reality is that employers have to think of their share of the Social Security tax as part of employees’ earnings, which increases their labor cost and requires them to lower the amount they pay out in salaries or wages.

Social Security Administration Social Security Changes, 2010–2021
Year Maximum Taxable Amount % Increase
2021 $142,800 3.7%
2020 $137,700 3.6%
2019 $132,900 3.5%
2018 $128,400 1%
2017 $127,200 7%
2016 $118,500 0%
2015 $118,500 1%
2014 $117,000 3%
2013 $113,700 3%
2012 $110,100 3%
2011 $106,800 0%
2010 $106,800 0%

Source: Social Security Administration

Example

A worker who earned $127,200 in 2016 would have paid Social Security taxes of 6.2% on $118,500, or $7,347. Their employer would have paid another $7,347 in Social Security taxes. If that individual was self-employed, the employer portion was the individual’s responsibility.

A worker who earned $127,200 in 2017 would have paid Social Security taxes of 6.2% on all $127,200 of income, or $7,886.40, an increase of $539.40. The employer (or the individual, if self-employed) would have matched that higher amount.

The Long-Term Funding Problem

The federal Social Security program that pays retirement, disability, and survivors insurance benefits is in serious trouble. These benefits are paid from two trust funds, the Old Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund.

The combined trust funds held $2.9 trillion at the beginning of 2020 but are projected to run out of money in 2034, according to the summary of the 2021 annual report from the Social Security and Medicare Board of Trustees. That date is soon enough to affect millions of current and future retirees.

Social Security (OASI) Retirement Benefits

The Social Security fund (OASI) will run out of money earlier than the combined trust funds. Social Security benefits are paid out of the Social Security taxes collected from current workers and the interest payments the government collects on Treasury bonds.

According to the SSA’s 2021 annual report, retirement benefits will be paid on schedule until 2033. After that point, the fund will be exhausted, and only 76% of the scheduled benefits will be able to be paid from continuing tax income. Congress will need to make changes to replenish the fund so that retirees can continue to be paid the full coverage.

The 2021 financial projections include the SSA’s best estimates as to the impact of the COVID-19 pandemic, but the report noted that the fund had been significantly affected by the pandemic and the 2020 recession.

Disability Insurance (DI) Trust Fund

The 2021 annual report also showed that the Disability Insurance (DI) Trust Fund, which pays disability benefits, is forecasted to make scheduled benefit payments until 2057. At that time, the fund’s reserves will be depleted, and continuing tax income will be enough to pay 91% of scheduled benefits.

Reasons for the Shortfalls

The large number of baby boomers entering retirement, combined with the smaller younger generations working and paying into Social Security, is a major cause of the shortfall. Whereas there were 3.2 workers to support every retired beneficiary in 1975, currently, there are just 2.7 workers, and in 2040 there might be only 2.1 workers.

In 2021, the Congressional Budget Office estimated that the projected increase in Social Security spending was not as dramatic as might be expected: from 5.2% of GDP in 2021 to 6.3% in 2051. 

Bottom Line

Increasing the Social Security cap helps, but it does not solve the impending Social Security shortfall. The tax cap would have to be eliminated entirely to close a significant percentage of the Social Security gap, according to calculations by the Committee for a Responsible Federal Budget—a think tank that publicizes Social Security and other federal budget issues.

Even that drastic measure would be far from a complete fix. Truly solving the problem will require a combination of measures, such as higher Social Security taxes, lower benefits (perhaps only for the well-off), and indexing the retirement age to life expectancy.

Articles You May Like

ChargePoint Stock Presents an Excellent Chance for Long-Term Investors Here
Hyliion Holdings Stock Isn’t as Cheap as It Looks as Costs Rise and Hope Fades
Are the FAANG Stocks About to Break Out Again?
The Worst May Be Over for Aterian Investors
Tilray Will Need to Break the Bank to Achieve Its Revenue Target