It’s not exactly accurate to say Social Security is taxed twice, but it can certainly feel that way. This is often attributable to people seeing Social Security being withheld during their entire working life, then finding out in retirement that those earned Social Security benefits are themselves being taxed as income.
Social Security is essentially a mandatory retirement savings program funded by the Federal Insurance Contribution Act (FICA) taxes you and your employer pay each year. Conceptually, the government views it as a savings account for your retirement rather than a traditional tax on income to fund the government. In that respect, the benefit payment you receive from that “savings account” is only taxed as income when you finally receive it in retirement.
The program has been running at a deficit in recent years, meaning more is paid out in SS benefits than is taken in via the Social Security portion of FICA taxes paid by current workers. In their annual trust fund summary for 2022, the SSA says the program was paying monthly benefits to 66 million people in total. Approximately 181 million workers paid FICA taxes that year.
They estimated that more than 40 percent of SS beneficiaries paid income tax on their benefits, and those taxes go into the Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) Trust Funds as well as the Medicare Hospital Insurance Trust Fund.
What Does the Social Security Trust Fund Depletion Mean?
Depletion of the Social Security trust fund, which is projected to occur in 2034, doesn’t mean the fund will be entirely empty. It simply means that, in that year, the fund’s income is projected to only cover approximately 80 percent of scheduled benefits. Unless legislation is passed to correct the issue in some way, SS beneficiaries may experience a roughly 20 percent reduction in their benefit payments once depletion occurs.
Potential Solutions to Avert Depletion or a Reduction in Benefits
There are a variety of potential legislative solutions that have been floated to avert the depletion cliff. One potential solution is to increase the FICA tax rate (current 15.3 percent) or lift the cap on taxable wages. The portion of this tax that goes to funding Social Security is 12.4 percent – 6.2 percent paid by the employer and 6.2 percent paid by the employee.
It’s been theorized that an increase from 12.4 percent to 15.84 percent, if passed right away, would make up for the projected shortfall. If the tax increase was put off until the shortfall arrives in 2034, the SS part of FICA would need to increase to an estimated 16.55 percent to account for the 20 percent shortfall.
The exact estimated figures change annually due to the variety of factors that play into benefit calculations, from inflation adjustments to the number of workers paying into the funds and the number of retirees claiming benefits.
An alternative solution may be to strategically reduce benefits. Some potential ideas that have been suggested include:
- Raising the retirement age (both when you can begin claiming benefits and full retirement age)
- Reducing the SS benefits paid to high earners
- Changing the way in which benefits are calculated
Many experts advocate for a combined approach to minimize the impact on taxpayers and beneficiaries. That could entail slightly increasing the Social Security part of FICA taxes, raising the retirement age (especially for younger workers) and taking steps to tweak the benefit formula, especially for high earners.
There Are No Easy Solutions – But Social Security Isn’t Going Away
Social Security is a hot-button issue. Older people are the most reliable and consistent voters in the nation, and politicians on both sides of the aisle go to great lengths to avoid alienating this vital demographic.
The doomsaying and inflammatory rhetoric can sometimes make the situation sound more dire than it is. While a 20 percent reduction in benefits would be a serious problem for many retirees on a fixed budget, it’s a far cry from a complete loss of Social Security.
Even policymakers who advocate for changes typically go to great lengths to reassure current and near-future retirees that they won’t lose their benefits or have their full retirement age increased. In fact, the last time the full retirement age was increased was more than 40 years ago in 1983, when FRA was increased from 65 to 67 based on year of birth.
Get Help Maximizing Your Benefits
Current retirees in Phoenix, as well as those who are planning for future retirement, who are concerned about their future benefits may find speaking to an experienced retirement planning professional helpful. The team at Fullerton Financial Planning has extensive experience helping savers plan for the future and maximize their benefits in retirement. Call us to speak with a financial advisor today.
