What is meant by the social security earnings cap and how does that affect my future benefits?

Ralph Estep Jr.:
00:00

Have you ever wondered why your Social Security benefits might be less than you're expecting? Well, stay tuned to find out about the Social Security earnings cap and how it could impact your future. Imagine working hard your entire life only to discover that your Social Security benefits are capped. Don't let this catch you off guard. Knowledge is power, and today's episode will arm you with the information you need to plan for a successful financial future.

Ralph Estep Jr.:
00:31

Before we dive in, let's take a quick glance at yesterday's show where we discussed the tax implications of gifting stock to someone. Check it out if you missed it. All of our episodes are located at askralph.com.

Ralph Estep Jr.:
00:46

Now let's dive into today's topic with a message from one of our listeners. This comes from Shannon in Saint Augustine, Florida. I love Saint Augustine, what a great place to visit. Shannon writes this, "Dear Ralph, I recently started a new job with a significant pay increase. I'm excited about the opportunity, but I've heard something about a Social Security earnings cap. Can you explain what this means and how it might affect my future benefits? I want to make sure I'm planning correctly for retirement. Thanks for your help and for the show. It's been a real blessing in my financial journey."

Ralph Estep Jr.:
01:19

Well, thank you, Shannon for this excellent question and congratulations on your new position. It's one that many listeners might be wondering about, especially as they progress in their careers and see their incomes rise. Welcome, listeners to another financial Friday edition of the Ask Ralph Show. I'm your host, Ralph, and I'm thrilled you've joined us today. As always, I'm here to help you master your finances from a Christian perspective.

Ralph Estep Jr.:
01:44

Before we dig into the answer, let's turn to the Word for guidance. The book of Proverbs chapter 21 verse 5 tells us, "The plans of the diligent lead surely to abundance, but everyone who is hasty comes only to poverty." This verse reminds us of the importance of careful planning and diligence in our financial lives, which is exactly what we're doing by understanding concepts like the Social Security earnings cap.

Ralph Estep Jr.:
02:13

Now, let's breakdown what the Social Security earnings cap is and how it might affect your future benefits. The social security earnings cap also known as the contribution and benefit base is the maximum amount of earnings subject to social security tax in any given year. In other words, it's the ceiling on the amount of your income that can be taxed for social security purposes. Now in 2024, the social security earnings cap is set at $168,600. This means if you earn $168,600 or less in 2024, all of your earnings will be subject to social security. However, if you earn more than this amount, you won't pay that social security tax on the portion of your earnings above that $168,600.

Ralph Estep Jr.:
02:57

Well, now you might be thinking, "Great. I won't have to pay as much in tax if I earn over the cap." Yes. But here's the catch. And this is important so listen closely. The earnings cap doesn't just limit how much you pay in, it also limits how much you receive in benefits later on. Your social security retirement benefit is based on your highest 35 years of earnings, up to the cap for each year. This means that any income you earn above the cap in a given year won't increase your future social security benefits.

Ralph Estep Jr.:
03:27

Well, let's break this down with an example. Let's say you earn $200,000 in 2024. So you only pay social security tax on that first $168,600, and only on that $168,600 will count towards calculating your future benefits. The additional earnings of $31,400 won't be taxed for social security, but it also won't boost your future benefits. So when you look at your prospective benefits and you look at your annual earnings, you're only going to see up to the cap. I actually had a question from a client a week or two ago about that.

Ralph Estep Jr.:
03:59

Now you might be wondering, "Ralph, why does this cap exist?" Well, the social security system was designed to provide a basic level of income for retirees. Wasn't designed to fully replace their high incomes. The cap helps maintain this principle while also putting a limit on the maximum benefit than any individual can receive. So there really is a top max that you can get. It's worth noting that the earnings cap typically increases each year to keep pace with inflation.

Ralph Estep Jr.:
04:24

Now, back in 2020, think about this for a second. It was $137,700, and it's been steadily climbing since then. So, as your income grows over time, the cap is likely to increase as well. It's also a way to try to shore up the social security fund. We talked about that in another episode, but think about that for a second. So from 2020 to 2024, that cap has gone up by $30,000 and people want to say there's no inflation.

Ralph Estep Jr.:
04:51

So Shannon, and all of our listeners out there, how does this affect your retirement planning? That's really the question here. Well, first, if you're earning above the cap, it's crucial to recognize that you're going to need additional savings to maintain your lifestyle in retirement. I'm making an assumption that if you're making that much money, you're spending that much money. And social security alone won't be enough. Truth is, you should not count on social security as your only form of retirement. I've mentioned this in other shows and social security is really only intended to replace about 40% of your full retirement income.

Ralph Estep Jr.:
05:24

Second, it's a reminder of the importance of diversifying your retirement savings. While social security is an important piece of the puzzle, it shouldn't be your only plan for retirement income. Third, it underscores the value of tax advantaged retirement accounts. That's those 401(k)s or IRAs or SEP plans. These accounts can help you save more for retirement, often with tax benefits that can help offset the higher social security taxes you might pay on earnings below the cap. Many of my clients use this hitting of that annual cap to add more money to their retirement every year. And that's really a great plan.

Ralph Estep Jr.:
05:59

Well, let me share a personal experience that illustrates the importance of understanding these nuances in our retirement system. A few years ago, I was advising a client. Let's call him Tom. Tom had always been a high earner and he assumed that his social security benefits would be substantial. He was shocked when he sat down to review his expected benefits and found they were much lower than he'd anticipated. What was the reason? It was the earnings cap. Tom had been earning well above the cap for most of his career, but he hadn't realized that his additional earnings weren't increasing his future benefits.

Ralph Estep Jr.:
06:31

This was truly a wakeup call for Tom and we had to quickly adjust his retirement strategy to make up for the shortfall. This experience taught me two important lessons that I want to share with you. The first one is this. Never assume when it comes to your finances. You got to take the time to understand the rules and how they apply to your specific situation. Second thing. Start planning early. The sooner you understand concepts like the earnings cap, the more time you have to adjust your retirement strategy accordingly.

Ralph Estep Jr.:
07:03

Now I can almost hear some of you thinking, "but Ralph, I'm nowhere near that earnings cap. Why should I even care about this?" Well, my friends, there are a few reasons. First. You never know where your career might take you. You might find yourself earning above the cap in the future, and it's better to be prepared than to be surprised. Second. Understanding how social security works can help you make informed decisions about your overall retirement strategy, regardless of your income level. It's always good to know what's going on.

Ralph Estep Jr.:
07:32

And third. This knowledge can help you better steward your finances, which an important part of our Christian Walk. Remember what 1 Timothy 5:8 tells us. "But if anyone does not provide for his own, and especially for those of his household, he has denied the faith and is worse than an unbeliever." That one stings. Understanding these financial concepts helps us better provide for ourselves and for our families.

Ralph Estep Jr.:
07:59

So Ralph, what are some actionable steps you can take based on what we've discussed today? First thing, stay informed. The social security administration updates the earnings cap each year. You need to make a habit to check these updates annually, especially if your income is approaching or exceeding the cap. You can go to ssa.gov for more information. Second. Maximize your other retirement savings. If you've listened to my show, you know I talk about this. If you're earning above the cap, consider increasing your contributions to your 401(k) or IRA, whatever retirement account you have to make up for that limitation on your future social security benefits.

Ralph Estep Jr.:
08:37

Third. Consider working with a financial advisor who understands these nuances of the social security system. They can truly help you develop a comprehensive retirement strategy that takes the earnings cap into account and that is really important. Fourth. If you're married, you need to coordinate your social security strategy with your spouse. You don't live in a bubble by yourself. Sometimes, creative claiming strategies can help maximize your combined benefits.

Ralph Estep Jr.:
09:02

And fifth. Remember that social security is just one part of a comprehensive retirement plan. You got to focus on building multiple income streams for retirement, including personal savings, investments and perhaps even a part-time business or ministry in your later years.

Ralph Estep Jr.:
09:17

Well now let's recap what we've covered today. The social security earnings cap is the maximum amount of income subject to social security tax each year. As we discussed, in 2024, this cap is $168,600. Earnings above that cap aren't taxed for social security, but they also don't increase your future benefits. And this cap means that high earners need to save more in other ways to maintain their lifestyle in retirement. And finally, understanding the cap is crucial for effective retirement planning, regardless of your current income level. Remember my friends, as I always say, knowledge is power when it comes to your finances. By understanding concepts like the social security earnings cap, you're taking an important step towards financial and responsible stewardship of the resources God has blessed you with.

Ralph Estep Jr.:
10:05

Now, before we wrap, I want to remind you that on tomorrow's show will be a special replay of an interview I had on the weekly wealth podcast. We covered some fascinating topics about integrating faith and finances. So you don't want to miss it. That's on tomorrow show. And now it's time for our call to action. If you found today's episode helpful, I encourage you to visit our website. That's at askralph.com and join our community. When you do, you'll get a free copy of my book, Mastering your Finances. Now this book normally sells for $10 on Amazon, but it's yours absolutely free when you join our email list. It's packed with practical advice to help you navigate your financial journey from a Christian perspective.

Ralph Estep Jr.:
10:43

Also, don't forget, share this episode with friends or family members who might benefit from understanding of the social security earnings cap. You never know. You might be helping someone avoid a major financial planning mistake. And please, please, keep those questions coming. The whole point of The Ask Ralph Show is to answer your financial questions so don't be shy. Your question could be featured on a future episode, just like Shannon's was today.

Ralph Estep Jr.:
11:08

And as we close, I want to leave you with this thought. Our financial decisions, both big and small are opportunities to honor God and serve others. By being diligent in understanding and managing our finances, we're not just securing our own future. We're positioning ourselves to be a blessing to others and to further God's kingdom. Well, thank you for tuning in today's episode of The Ask Ralph Show. Until next time as I always say, stay financially savvy, and God bless you abundantly.