Social security is an excellent source of retirement income for people who have earned it; however, it can be somewhat confusing and overwhelming to understand how much you will receive. Social security is a pay-as-you-go system that benefits retired workers and their dependents based on their past income levels and current earnings through Social Security Administration’s (SSA) Trust Fund.
The SSA estimates that approximately 125 million working Americans have reached or are at least partly eligible for retirement. If you’re one of them, it’s essential to know how much money you need to collect throughout your career to maximize the value of Social Security.
This article will help you examine how Social Security works and how it can impact your business and maximize your benefits.
What Is Social Security?
“Social security” is a government-run program, and it is also referred to as the “Old-Age, Survivors, and Disability Insurance (OASDI)” program in the United States. It is managed by a federal agency known as Social Security Administration (SSA) and is funded by payroll taxes, which are deducted from your paycheck. Even though it is most recognized for its retirement benefits, it also provides income for disabled workers and survivor benefits.
How Are Your Social Security Benefits Calculated?
Your Social Security benefits are based on your average income throughout your working life. Remember that the amount you receive is based on when you retire. If you retire at full retirement age, you will get 100% of the amount you’re entitled to. But your benefits will be reduced if you retire before the full retirement age. To get an estimate of what your benefits might be, read further:
- Know your monthly average indexed earnings: The ‘35 years’ of your highest wages are adjusted for inflation.
- Apply Bend Points: Social Security benefits are reduced with higher income compared to the first dollars of wages.
BEND POINTS 2022
What percentage of your monthly salary goes toward Social Security benefits?
$0-$1.024/month: 90%
$1.025-$6.172/month: 32%
$6,173-$12,250/month: 15%
- Amount of primary insurance: if you take social security (SS) at full retirement age, you will benefit from Full Retirement Age (FRA)
- Early retirement penalty: The monthly payment is reduced if benefits are started before FRA.
- Credit for delayed retirement: The monthly payout increases when benefits are started earlier than FRA.
Are Payroll Taxes Doubled for Business Owners?
Regarding Social Security, business owners get hit with double the payroll taxes. That’s because they must pay the employee and employer contributions to social security every year. Whether you are an employee or a business owner, the Social Security Administration (SSA) receives the same amount of cash.
The self-employment payroll tax for 2020 is 15.3% on the first $147,000 of your income, which will increase to $160,200 in 2023. 12.4% of the 15.3% payroll tax is for Social Security, and 2.9% is for Medicare. There are many options to consider, so it’s best to consult with a financial planner to see what would work best for you.
The Basic Principles of Social Security Benefits for Business Owners
Let’s imagine you manage a company with a $200,000 annual profit. You would not be required to pay Social Security taxes on $120,000 of your income, or more than half of it if you paid yourself an annual salary of $80,000. That’s a lot! But be aware that the IRS mandates that you earn a “reasonable” remuneration for yourself. So, be honest while looking at the average salary for those in your field. The IRS will likely visit you if you earn $50,000 yearly and collect $150,000 in owner draws.
With this strategy, you lower your Social Security benefits and save a significant amount of money on taxes each year.
Payroll Tax Savings
Business owners with high incomes can reduce how much of their income is hit with payroll taxes. Employers are required to pay themselves a fair salary, subject to payroll taxes. Although, paying yourself a very modest income will help you minimize payroll taxes. It will also lower your social security benefits.
If you use the tax savings to increase your contributions to retirement plans like a Solo 407 (k) or Cash Balance Pension Plan, this shouldn’t be a big problem. However, if you’re spending all of your tax savings, you won’t be able to save enough money to maintain your lifestyle in retirement. So, talk to your accountant and find the options that work best for you.
Higher Salaries Increase the Maximum Contributions to Retirement Plans
Another advantage of a higher salary is the ability to contribute more to retirement plans. In 2022, you can contribute $20,500 to a Solo 401(k), and your employer (and you) can contribute up to a quarter of your salary as a profit-sharing contribution.
Business owners 50 and older can make a mind-blowing total pre-tax contribution of $67,500 by incorporating a $6,500 catch-up payment. However, as of 2022, you must bring in at least $162,000 to be eligible to contribute the maximum amount to your Solo 401(k). Hence, a Cash Balance Pension Plan is something that people with higher earnings should consider.
Bottom Line
As a business owner, how much salary should you take to maximize your social security benefits? That’s a question that many new business owners ask themselves. Even though there isn’t an ideal answer to this question, it depends on some elements, including your age, your earnings history, the working history of your spouse, and whether you have other sources of income.
You may also want to consider if you can afford to pay more after factoring in taxes and other deductions. In addition, if you have other employees eligible for Social Security benefits, the income you take from them should also be considered.
But you must understand that your income will only affect your social security benefits until you reach retirement age. In other words, social security will not adjust your benefits based on how much you make after that point.
