The annual increase to the maximum earnings subject to Social Security tax is always a footnote to the announcement of the next Social Security cost-of-living adjustment, but for today’s workers, it might be even more important.
Boost to Social Security Payments
The annual COLA announcement gets the most attention because a real dollar amount is added very soon after to the checks of seniors who are already claiming Social Security, thereby helping them cope with inflation. The boost for 2024 will be 3.2%, which is obviously less than the 8.7% seniors got in 2023 but still amounts to an average $60-a-month increase. Plus, the additions compound on top of each other, so seniors will effectively be getting, on average, around $200 more per month than they were getting in 2022.
The Importance of Wage Base
The wage base, on the other hand, is what determines what your Social Security check amount will be in the first place. The COLA is just a tweak to that amount. The maximum earnings subject to Social Security taxes will go up 5.2% next year, to $168,600, which is the real key to what will raise benefits down the line for those working today.
Tax Rates and Contributions
The tax rate on the income will stay the same at 12.4%, but the maximum real dollar amount a person making $168,600 or more will pay will be $10,453.20, with their employer paying an equal amount. A self-employed person pays double.
Funding Future Benefits
This is the money that goes into the system to pay for future benefits, and workers don’t owe this particular tax on earnings above that maximum amount. High earners typically notice this toward the end of the year, after their earnings exceed that maximum and their take-home pay increases slightly.
The Mechanics of Wage Indexing
Since the 1970s, the Social Security system has utilized the Average Wage Index (AWI) to calculate benefits. The AWI takes into account W-2 income and has a two-year delay. To determine the annual cost-of-living adjustment, the system relies on the CPI-W, a consumer-price index that assesses third-quarter inflation in comparison to the previous year.
Wage Growth Outpaces Inflation
Devin Carroll, a respected Social Security expert and financial planner, notes that wages have increased at a faster rate than inflation this year. This is significant because the average wage formula impacts various aspects of Social Security, including the maximum taxable wage base, maximum family benefit, and the minimum credit requirement.
Enhancing Future Benefits
Carroll emphasizes that these wage increases are positive news for Social Security beneficiaries. They result in a boost to future benefits by pushing up the wage index in the year individuals start receiving benefits. Consequently, when determining your Social Security benefits, the agency analyzes your previous earnings and factors in the AWI through a formula that inflates those earnings to account for wage growth. As the average wage index rises, the indexation of prior earnings increases as well.
Compound Growth through Cost-of-Living Adjustments
The cost-of-living adjustment (COLA) is added on top of the base benefit amount for all workers, not exclusively retirees. Unlike other adjustments, COLAs never diminish or negate the base benefit. As a result, the base benefit continues to grow incrementally. Carroll acknowledges that there is often confusion surrounding this point: COLAs apply to both current beneficiaries and those who have yet to claim benefits, even if they file at a later age.
In essence, wage indexing provides a mechanism that ensures Social Security benefits keep pace with inflation and wage growth over time. By understanding its mechanics, individuals can better comprehend how their earnings and future benefits are interlinked.