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California’s Latest Stealth Tax: What You Need to Know

In 2023, the California State Disability Insurance (SDI) payroll tax was applied to wages up to a maximum of $153,164. This year however - thanks to legislation passed in 2022 (SB 951) - California has removed this wage cap (EY Parthenon, 2023). Now, the current 1.1% SDI tax applies to all wage income without any limit. In this blog we will discuss the impact it may have on employees, and what you can do.

But first…

What is the CA SDI program?

It is wholly funded by employee mandatory withdrawals and often appears as “CA SDI” on paystubs, and the rate varies by law from year to year but has tended to be around 1%.

Here’s how the removal of the wage cap may impact you. If your salary is $300,000, you’ll pay more than double the tax compared to the prior year. For 2024, that amounts to $3,300 (versus $1,378 last year).  If you receive wages over the course of a year, you might not have noticed this stealth tax yet, but you will soon.

What can you do as an employee?

Here’s what California employees can do about the SDI changes.

  • Review your paystub and consider adjusting your elections. With less take-home pay, you may need to revise retirement plan contributions, FSA/HSA allocations, and tax withholding.

  • Negotiate the best salary/compensation package you can to help offset the higher taxes.

  • Be aware of your access to benefits and use them when applicable (you paid for them, after all):

    • SDI provides short-term “wage replacement” benefits for non-work-related injuries, pregnancy, or elective surgery (EDD, “About the SDI Program”).

    • Paid family leave (PFL) has expanded in recent years, covering situations like caring for a seriously ill family member or bonding with a new child.

  • Think about long-term disability risks and consider working with a professional to address this.  We often find that people have no idea that there is limited to no income replacement coverage for a prolonged disability during their working years – and this is particularly true for those in professions that require special skills, education, or experience like doctors, dentists and lawyers. 

  • Having disability coverage is an essential part of a financial plan and it is critical to protect your dependents. If you require assistance figuring out how much coverage you need and where to get it from, please set up a time to talk with us.  While we do not sell insurance directly, we work with clients, brokers, and insurance companies to address this risk in a meaningful way.

What You Get for the Increased Tax

For higher-income employees, the SDI wage replacement benefit increases from 60% to 70% of your wages starting January 1, 2025.  For lower paid workers - who earn less than the average California wage - the benefit increases from 70% to 90%.

The maximum weekly benefit amount in 2024 is expected to be $1,698, and these benefits can last up to 52 weeks (EDD, DI Fund Report).

Opportunity for Employers

Employers can opt out of California’s SDI by establishing their own short-term disability plan – a “voluntary plan” – approved by the California Employment Development Department (EDD, “Voluntary Plan”). They can potentially offer better benefits at a similar cost or match state benefits at a lower cost; in addition, they can add this coverage as a paid benefit which gets their team more take-home pay.

Based on the documentation on the EDD website, establishing and maintaining a voluntary plan is not a simple task.  However, based on the relatively low level of adoption and high covered wages for these plans, employers with highly paid teams or large payroll obligations seem to find having a voluntary plan worthwhile (EDD, DI Fund Report).

Opportunity for Self-Employed Individuals

For self-employed individuals and contract workers (paid by 1099), it can be a significant challenge to get disability insurance coverage because of the nature of their profession, business earnings, or their health history.  For them, California presents a unique opportunity through the use of the Disability Insurance Elective Coverage (DIEC) program to get a limited amount of coverage with no medical underwriting.

  • DIEC only requires that the self-employed person earn net income over $4,600/year.

  • Benefit eligibility is similar to that for employed workers (DI and PFL), and begins six months after the plan’s start (EDD, “Information Sheet”).

  • Covers workplace injuries (this is helpful since workers’ comp insurance isn’t required for the self-employed).

  • Coverage lasts for 39 weeks (instead of 52), but benefits are not as clear-cut (benefits are based on an “income factor”).

Costs are not cheap—the DIEC rate for 2024 is 9.78% of reported net income (EDD, “DIEC Rate Notice”). For this reason, it’s not a decision to take lightly. Self-employed should carefully consider how the risk of an injury or prolonged disability would affect their overall goals and financial standing.

Summary

Understanding how the change to the CA SDI wage cap works will help you prepare for a possible reduction to your take-home pay.  This is also an opportunity to consider the risk of injury and how a longer-term disability would affect your financial goals. 

Employers should consider whether a voluntary plan could make sense given their circumstances.  Both employed and self-employed individuals should carefully consider their choices and consider working with a professional to navigate this landscape effectively.

We are California financial advisors serving La Jolla and beyond. Please contact us if you’d like to set up a time to speak.

 

Chris Jaccard, CFP®, CFA is a lead advisor with Financial Alternatives in La Jolla, CA. When he’s not working on home improvement projects or trying to keep up with his kids, he loves to help successful families consider their alternatives and make better financial choices with the EXPERT™ Advisory Process. Schedule a time to chat about your situation or the latest project.

 

Sources

Employment Development Department. State of California. About the State Disability Insurance Program. https://edd.ca.gov/en/disability/About_the_State_Disability_Insurance_SDI_Program/

Employment Development Department. State of California. May 2023 Disability Insurance (Di) Fund Forecast. https://edd.ca.gov/siteassets/files/pdf/edddiforecastmay23.pdf

Employment Development Department. State of California. Voluntary Plan. https://edd.ca.gov/en/disability/Employer_Voluntary_Plans/

Employment Development Department. State of California. Information Sheet. Elective Coverage For Employers And Self-Employed Individuals. https://edd.ca.gov/siteassets/files/pdf_pub_ctr/de231ec.pdf

Employment Development Department. State of California. Disability Insurance Elective Coverage Rate Notice and Instructions for Computing Annual Premiums. https://edd.ca.gov/siteassets/files/pdf_pub_ctr/de3dii.pdf

Employment Development Department. State of California. Contribution Rates, Withholding Schedules, and Meals and Lodging Values. https://edd.ca.gov/en/payroll_taxes/rates_and_withholding/

Employment Development Department. State of California. May 2023 Disability Insurance (DI) Fund Forecast. https://edd.ca.gov/siteassets/files/pdf/edddiforecastmay23.pdf

EY Parthenon. (26 June, 2023). 2023-1134. Tax News Update, U.S. Edition. California will require state disability insurance contributions on all covered wages starting in 2024. https://taxnews.ey.com/news/2023-1134-california-will-require-state-disability-insurance-contributions-on-all-covered-wages-starting-in-2024

Chris Jaccard, CFP®, CFA