Social Security

Why can up to 85% of my Social Security benefit be taxed?

Many people think they “paid for” their Social Security benefits and then it is double taxation to pay again. Not according to Social Security 

“In 1993, SSA’s Office of the Chief Actuary estimated that the payroll tax contributions of current and future workers would equal less than 15% of the present value of their lifetime benefits (Goss 1993). Therefore, if the ratio of lifetime contributions to benefits is less than 15%, then up to 85% of benefit income can be taxed without risk of double taxation.”

Of course this math works for everyone, but Congress saw fit not to apply it to all income levels.

Taxation of up to 50% of benefits began in 1983 (employees pay 1/2 the payroll tax) and was later raised to 85%, the extra amount collected in taxes goes to fund Medicare. 

The income at which taxation begins is not indexed for inflation so over time more seniors will be paying income taxes. In 1984 10% of beneficiaries paid income tax on a portion of their benefits. Today more than 52% pay income tax on their Social Security benefit. 

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Categories: Social Security

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8 replies »

  1. Since most people get everything paid into SS back in 6 to 8 years, I feel it should be no problem having to pay taxes on SS income. Because my wife never worked and will get 35% of my benefit when we start getting our benefit at 62, I will get everything back in 38 months. The best forced investment, I could of hoped for when I entered the workforce in 1971.
    The problem is they did not tax me enough, for the future benefit I would receive.
    What many people do not remember over 40 years ago, many paid SS taxes on incomes below $10,000 many of their working years. But, benefits have been adjusted up for lower income workers above inflation rates. No COLA for 2016, but my projected benefit in 2 years, increased $30 per month, why????? We need to raise the SS tax and slow the growth in future benefits or it is going to be a train wreck in 2033 or sooner.

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    • “Since most people get everything paid into SS back in 6 to 8 years, I feel it should be no problem having to pay taxes on SS income. Because my wife never worked and will get 35% of my benefit when we start getting our benefit at 62, I will get everything back in 38 months. The best forced investment, I could of hoped for when I entered the workforce in 1971.”

      Benefit Jack says:
      (1) Adjust your numbers for the interest on the contributions.
      (2) Adjust your numbers for the employer financial support.
      (3) Adjust your numbers for the interest on the employer contributions.
      (4) Adjust for the fact that the contributions you made were on an after-tax basis – versus what you could have contributed on a tax effective basis to a 401(k) plan.

      So, after you take those four actions, even though your spouse never worked, it will be at least 15 years before you have recovered your contributions, the employer contributions, earnings for the government using your money for 45+ years while you were contributing and the government using the money another 15+ years after payouts start.

      For comparison, once I consider everything, I will NEVER receive any of the contributions I made, or any contributions made by my employer. That is, assuming I follow through on my plan, and commence my benefit at age 70, in seven years, the earnings on my accumulated contributions, the accumulated employer contributions, and the earnings on my contributions (assuming 6%) over the past 45 years and the next seven years, the earnings alone on those accumulated assets over the 53 years I will have paid in, the interest that should have accrued EXCEEDS the present value of my monthly benefit commencing in 2022. Worse, because my wife worked as a teacher, there is the Government Pension Offset. So, just like your wife, she paid in very little to Social Security, but unlike your wife, who you indicate never worked outside the home, mine worked as a teacher in the state of Ohio. As a result, two thirds of her spousal social security benefit will be forfeited!

      For many of us, Social Security is already a TRAIN WRECK!

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      • Since I have never made more than $25,000 ($25,000 was my highest in 1994) in taxable income my entire working life and stopped working at age 50, none of the money I could of invested would of paid me anything close to what my SS benefit will amount to. I do not have to do any more math to know that I will receive way more than the $38,000 I and my employer were taxed over the 27 years I have had earned income that was taxed for SS. Age 62 to 75, 13 years of benefits will = $178,932.
        If I live to be 86 like my mother who has received $151,00 and counting over 21 years and never had household income above $15,000 from 1948 to 1995, not very much paid into SS, my benefit total will = $330,336.
        What too many people do not want to admit is SS has always been a welfare program for the lower middle class,not a retirement investment program.

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    • My error. I had assumed, incorrectly, that you had higher wages and paid higher taxes. You clearly benefit from the “Social” component of “Social Security” – a benefit formula that is heavily weighted to benefit those individuals who did not work 35 years and those individuals who had modest incomes.

      The formula for someone who is age 62 in 2016 is:
      (1) Calculate average indexed monthly earnings (AIME) – take highest 35 years of earnings (once adjusted for inflation), including years with $0 earnings, and divide by 420 (35 years * 12 months), remembering to cap wages at the Social Security Wage Base ($3,000 in 1937, now $118,500 in 2016).
      (2) To calculate your primary insurance amount (PIA), the benefit payable to you at Social Security Normal Retirement Age, plug that AIME average indexed wage number into the following formula – the sum of:
      (a) 90 percent of the first $856 of AIME, plus
      (b) 32 percent of AIME > $856 but less than $5,157, plus
      (c) 15 percent of AIME > $5,157.

      So, if a person’s average indexed monthly earnings is $2,000 a month, the monthly benefit for someone turning age 62 this year, would be 90% of the first $856 ($770), plus 32% of ($2,000 – 856) or $366, for a total, at age 66 (assuming the person was born between 1943 and 1954) of $1,136, reduced for commencement at age 62 to about $850.

      It is not “welfare” but Congress intentionally created a “regressive” benefit formula – where benefits are intentionally a higher percentage of wages as wages decrease. Certainly, the only thing more regressive than social security and medicare taxes are the benefits they fund.

      Please excuse my mistaken assumption(s).

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      • I feel even the higher paid worker who pays his 5.2% and his employer pays their 5.2% on the higher income still comes out ok, if their other retirement income does not trigger high tax rates. I have never understood the government pension offset and think it should be changed, because the person qualifies for both systems. In many cases paying into both systems for many years.
        I think the way Congress looks at it is the higher wage earner has more income to invest over his working years to offset any loss in SS benefits compared to the low paid worker, as a percentage of taxes paid. .
        My sister who has made 2 to 3 times my income over her working life, with no zero years, will receive a family benefit of $269,730 by age 75. And a family benefit of $599,400 by age 86. $90,798 more than me by age 75 and $269,064 more than me at age 86. Still not a bad deal, she will still be getting double what was paid in in taxes.. That being said SS tax rates need to be increased, if we are going to keep benefits at the same level.

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      • “I feel even the higher paid worker who pays his 5.2% and his employer pays their 5.2% on the higher income still comes out ok,”

        The tax rate is 6.2% employee and 6.2% employer on the first $118,500 in 2016.

        In terms of raising taxes, the problem is that the target has been those people who already pay disproportionately more in FICA and FICA Med taxes relative to the benefits they receive. Here, proposals to eliminate the cap on wages subject to FICA, comparable to the change in 1994 to lift the cap on taxes used to fund Medicare, we are talking about taxing income that will not be used in the determination of benefits – breaking apart what has been a core feature of Social Security for 80 years.

        It may yet happen. Like the change to Medicare, the tax is proportional to income. However, unlike Medicare Part A, where the benefit was always the same for all, regardless of your taxes, here, a change to the FICA wage base is inconsistent with 80 years of history. Similarly, where Medicare part A’s FULL hospital benefit (for the retiree, AND an equivalent benefit for a non-working spouse, as well as any former spouses who divorced after 10 years of marriage) is triggered by just 40 quarters of paying Medicare Part A taxes (FICA-Med) at minimal levels, So, again, the Medicare benefit was always dramatically more regressive, more favorable to those with lower wages and minimal years of paying into the system – even when compared to Social Security.

        The challenge here, of course, is that it is not only Social Security benefit taxation, it is all the surcharges that have cropped up – the surcharge for health reform, the surcharge for Medicare part B, the surcharge for Medicare Part D, and the coming “surcharge” from lifting the cap – where taxes are assessed on income that won’t be included in the benefit determination.

        Yes, the process does disproportionately benefit those who paid in the least. However, what is proposed these days is a significant rewrite of what “Social” means with regard to “Social Security”. Perhaps it will get to “welfare” status, as you noted, where the benefit to be provided is clearly remade into an entitlement, where the benefits to be paid are totally disconnected from the taxes that were once designed to fund these specific benefits.

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  2. Remember, prior to 1984, all Social Security benefits were paid tax free. So, obviously, Congress didn’t feel bound to fulfill the benefit promises made to workers who contributed during the period 1936 – 1983.

    And, don’t forget, while working, your contributions are “after-tax” – after federal, state, FICA, FICA-Med, local taxes are determined and paid. They come out of your net, net take home pay. So, if that represents 15% of the value, I assume another 15% would be the value resulting from employer “matching” contributions/taxes.

    Tell me why it isn’t the other way around – 85% tax free. That is, if my FICA “contributions” are made on an “after-tax” basis, they should accorded the same tax treatment as Roth contributions, and all payouts other than the 15% attributable to employer contributions should be treated on the same basis as Roth – where the return of contributions and associated earnings are tax free where they are part of the plan for over five years, and paid out after reaching age 59 1/2.

    Why did Congress approve better tax treatment for Roth in the 1990’s, than it approved for Social Security in the 1980’s?

    Obviously, Congress believes it can do whatever it wants to do with YOUR entitlements — since they are not contractual in any way. Let’s hope they do not adopt this same attitude about other tax promises like Roth – change the rules just about when today’s workers start to take payouts.

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