Social Security is the government’s retirement program, and can be a significant source of income for retirees. If you are an employee, you have most likely been paying into the program through the Social Security tax, the responsibility for which is shared with your employer. If you are self-employed, you have been paying the full tax.

Is Social Security a tax? The answer is that Social Security is funded by a tax. The program itself relies on a steady stream of workers paying into it in order to finance the benefits of retirees who paid into the system previously. After paying into the system, workers retire and can collect Social Security benefits.

Your Social Security tax payments will have an important effect on how much you are eligible for later in Social Security benefits. It’s a good idea to speak with a Certified Financial Planner® to get a sense of how much you have paid in, and what your options will be in retirement.

How the Social Security Tax Works

What is Social Security tax? If you’ve searched for “Social Security tax definition,” the answer is that this is a tax collected to fund Social Security.

Typically, your employer will withhold this tax as a line item listed as “FICA” from your paycheck and forward it to the government.

Where does Social Security tax go? What does Social Security tax pay for?

The main answer to these questions is that the government uses the tax to pay off existing retirees – people who previously paid into the system – with the understanding that the people who are currently paying into the system will get their turn to collect once they retire and start taking Social Security benefits.

Social Security tax is also used to fund survivorship benefits, that is to say benefits paid to a surviving spouse of a qualifying retiree, or a dependent child whose parent has died.

The Social Security tax rate is 12.4% for 2021, with 6.2% paid into the system by the employer and the employee each. This tax rate is applied to all income up to a specified annual limit, which is $142,800 for 2021. Income earned in excess of $142,800 is therefore not subject to the Social Security tax.

Social Security Tax for the Self-Employed

People who are self-employed pay the full 12.4% Social Security tax rate because they are considered both employers and employees. The term self-employment tax refers to this tax and the Medicare tax rate, 2.9%, meaning the full self-employment tax rate is 15.3%.

The self-employment tax is assessed on 92.35% of net business earnings, with the remainder not subject to self-employment tax.

Social Security Tax Exemptions

There are exemptions from Social Security taxes, categories of taxpayers who do not have to pay the Social Security tax.

Some religious groups are opposed to receiving Social Security benefits in retirement, in the event of disability, or after the death of a spouse. They are granted an exemption for this reason.

Nonresident aliens, that is to say people who are not citizens and not legal residents of the United States and are only in the country temporarily as students, do not have to pay Social Security tax.

Similarly, nonresident aliens who are in the United States working for a foreign government do not have to pay Social Security tax.

And finally, students who are employed at the same school where they are enrolled and whose employment is contingent upon continuing to be enrolled in the school do not have to pay Social Security tax.

How to Calculate Social Security Tax

If you are an employee, your employer will deduct the Social Security tax rate from your paycheck. This will include 6.2% that they will be responsible for and 6.2% that you will be responsible for – that is to say, they will pay 6.2%, and they will take another 6.2% directly out of your check.

If you earn more than the limit of $142,800, the tax will only be assessed on the first $142,800.

If you are self-employed, 92.35% of your net business earnings – that is to say, earnings after qualifying business expenses – will be subject to the full self-employment tax rate of 15.3% (includes 12.4% for Social Security and 2.9% for Medicare).

Find 92.35% of your net business earnings, and then take that sum and find 15.3% of it, and you’ll know how much your self-employment tax is.

Bottom Line

Social Security can be an important source of retirement income, as well as a source of income for surviving spouses of qualifying retirees and dependent children bereaved of a parent.

However, Social Security should not be your only source of retirement income. It is also important to consider the age at which you take Social Security benefits, since this will impact your benefit amount.