What is it?
Reducing or eliminating compensation in excess of the maximum earnings base is a strategy that may help you minimize Social Security payroll taxes or self-employment taxes. You can reduce or eliminate compensation you receive in two ways: (1) by working less or not at all once you have reached the maximum earnings limit in any one year, or once you have earned the maximum you can in each of the 35 highest earnings years used to calculate your Social Security retirement benefit, or (2) by converting your compensation to a nontaxable form.
Who can use this strategy?
You probably don’t work just to earn a future Social Security benefit. You work because you have to, because you like to, or because you’re not yet ready to retire. However, some workers (i.e., business owners) have more flexibility than others in determining how much they earn or how they’re compensated for working.
Anyone whose annual earnings have equaled or exceeded the maximum earnings base in at least 35 years of employment
Your Social Security retirement benefit is based on your average indexed monthly earnings (AIME). Your AIME is calculated by averaging your 35 highest years of indexed and nonindexed earnings and applying a benefit formula to that average. If, in each of those 35 years, you earned an amount equal to the maximum earnings base for that year, you will receive the maximum Social Security retirement benefit when you become entitled. If you continue to work once you have 35 years of maximum earnings recorded on your Social Security record, you won’t receive any additional retirement benefit, and the payroll taxes you pay will, in effect, be wasted. The maximum earnings base changes from year to year; in 2023, it’s $160,200.
Anyone who expects to have earnings in excess of the maximum earnings base during any one year
If your annual earnings exceed the maximum earnings base during any one year, you won’t pay FICA taxes on those excess earnings, but you’ll pay Medicare taxes on those earnings. When you reduce or eliminate the compensation you receive over the maximum earnings base, you’ll save payroll taxes on the excess amount. If you’re an employee, you will save 1.45 percent of that amount; if you’re self-employed, you’ll save 2.9 percent of that amount.
How does it work?
You estimate your lifetime or annual earnings
To estimate your lifetime earnings, you can go to the Social Security Administration’s website (ssa.gov) and sign up for a my Social Security account so that you can view your Social Security Statement. This statement includes a detailed record of your lifetime earnings. To estimate your current annual earnings, use your paycheck stubs or, if you’re self-employed, your self-employment earnings estimate.
Determine how much you might save in payroll or self-employment tax if you reduce or eliminate compensation
Determining how much you should save will depend on whether you’re the employer or the employee and how much your excess earnings are.
As a self-employed person, Cornelia earned $11,600 in excess of the maximum earnings base for that year. If she reduced her compensation to the maximum earnings base for that year, she would save $336.40 (2.9 percent of $11,600) in Social Security taxes.
Decide whether you can stop working or try to convert compensation to a nontaxable form
Once you determine how much in self-employment taxes or payroll taxes you can save, decide how you want to reduce or eliminate your compensation in excess of the maximum base amount. You might choose to stop working if, for example, you’re already past minimum retirement age (currently 62).
You might choose to convert compensation to a nontaxable form if you own a business or are employed by a business. Nontaxable forms of compensation (for Social Security purposes) include some fringe benefits and investment income.
Strengths
Can save payroll taxes that otherwise would have been wasted
The strategy is particularly effective if used by a business owner who can receive nontaxable benefits in lieu of salary. Or by a person who works after retirement and already receives a benefit close to the maximum due to the impact of excess earnings on a retirement benefit.
Tradeoffs
Your tax savings might be minimal if you use this strategy to reduce your payroll taxes in only one tax year
Note that in the example above, Cornelia only saved $336.40 by reducing her income by $11,600. If she had been an employee instead of being self-employed, she would have saved only half that amount. However, if she received nontaxable compensation or limited her earnings in several years, she might save enough to make using this strategy worthwhile.
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Broadridge Investor Communication Solutions, Inc. prepared this material for use by Social Security Benefit Planners, LLC.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Social Security Benefit Planners, LLC provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Social Security Benefit Planners, LLC and its affiliates are in no way associated with or approved, endorsed, or authorized by the Social Security Administration.