❯❯ Benefit levels are guaranteed. Unlike 401(k)s, for example, Social Security benefits are paid under legal formulas and don’t rise or fall based on your luck with investments, the fortunes of your employer, the direction of interest rates, or other forces over which you have no control.
❯❯ Benefits are universal. Social Security covers the rich, the poor, and – most of all – the middle class. Social Security is a kind of social insurance for the benefit of individuals and society. This makes it very different from a welfare program.
❯❯ Benefits are protected against inflation. Private pensions generally don’t have this feature. But without such protection, rising prices can take a huge toll on fixed income, one that adds up the longer you live.
SOCIAL SECURITY GROWS UP: SOME KEY DEVELOPMENTS
Since President Franklin D. Roosevelt signed Social Security into law in 1935, the program has evolved. Here are some key milestones:
1939: Congress added benefits for retirees’ spouses and minor children, as well as dependents of workers who die.
1950: Coverage was extended to farm workers, domestic workers (such as housekeepers and gardeners), employees of nonprofits, and self-employed nonprofessionals.
1954: Coverage was extended to self-employed farmers and certain professionals, such as accountants, architects, and engineers.
1956: Benefits were added for disabled workers ages 50 to 64 and adult disabled children of workers who earned benefits. Social Security introduced early retirement benefits for women only.
1960: Benefits were added for dependents of disabled workers.
1961: Men were given the option of early retirement benefits, five years after this choice was granted to women.
1965: Congress approved Medicare, a program of federal health insurance for people 65 and older, long sought by advocates of Social Security and social insurance.
1972: Congress approved annual cost-of-living increases for Social Security, linked to the rise in consumer prices. (It had previously approved some benefit hikes on an ad hoc basis.)
1977: Congress approved wage indexing, which adjusts retirement benefits upward to make sure that they reflect the long-term increase in wages that took place during a worker’s lifetime.
1983: Congress agreed to gradually raise the age for full retirement benefits from its traditional level of 65 to 67. That increase is still being phased in. The full retirement age has reached 66 for people born between 1943 and 1954 and will gradually move up to 67 for people born 1960 or later. The 1983 law also introduced taxation of Social Security benefits for higher-income retirees, a shift that is causing growing numbers of people to pay income taxes on part of their Social Security income.
2014: The Social Security Administration began to process and approve some claims for benefits related to same-sex marriage, including claims for spousal and survivor benefits in states that recognize such unions as legal. The new policy followed a Supreme Court ruling in 2013 that Section 3 of the Defense of Marriage Act was unconstitutional.
Understanding How You Pay for Social Security
Social Security is paid for through taxes. (No surprise there.) But you’re not the only one paying into the Social Security pot: Your employer also pays a portion of your Social Security tax. All that money that’s taken out of your paycheck today goes to pay the benefits for today’s retirees.
For the lowdown on how much you pay into Social Security and where it goes, read on.
If you’re a wage earner, you pay into the Social Security system straight out of your paycheck. This payroll tax is dubbed “FICA,” which stands for the Federal Insurance Contributions Act. The Social Security portion of your payroll tax is typically 6.2 percent of earnings up to a certain amount, which is adjusted annually (for 2017, the cap was set at $127,200). Employers also pay 6.2 percent for each employee. In addition, workers and their employers each pay 1.45 percent of all earnings for Medicare’s Hospital Insurance Trust Fund. As of January 2013, individuals who earn more than $200,000 ($250,000 for married couples filing jointly) pay an additional 0.9 % in Medicare taxes.
Politicians have been increasingly willing to ease the payroll-tax burden in response to economic conditions. In 2011, Congress approved a “payroll-tax holiday” to boost the economy; it lowered the worker’s tax rate to 4.2 percent instead of the usual 6.2 percent. Employers still paid the usual 6.2 percent. The self-employed paid an overall rate of 10.4 percent. (The payroll-tax holiday expired at the end of 2012. And chances of this holiday being reinstated in the near future aren’t good.)
Most workers pay Social Security taxes on all their earnings, because most workers don’t earn above the cap for Social Security payroll taxes. Well more than half – maybe three-quarters – of U.S. households pay more in Social Security taxes than in federal income taxes. Although no one enjoys paying taxes, people tend to accept the Social Security tax because it enables them to earn important benefits.
The taxes you pay in your working years pay for the benefits for retirees and other beneficiaries who no longer are working. This approach is called “pay as you go.” Think of it as a pipeline that goes from current workers to current beneficiaries.
What the government does with your payroll tax contributions has long been a source of rumor, misunderstanding, and strongly held views. Here are the facts: The Social Security payroll tax deducted from your wages goes into two U.S. Treasury accounts, where it’s used to pay for benefits. Most of the money – about 81 percent – goes into the Old-Age and Survivors Insurance Trust Fund; the remainder goes into the Disability Insurance Trust Fund. These combined trust funds are quite large, with assets of almost $2.8 trillion at the end of 2015.
Tax revenues above and beyond what’s needed to pay benefits are invested in special Treasury securities. These bonds have historically provided extra income for Social Security. Some critics argue that the trust funds could go belly up if the Treasury doesn’t make good on its borrowing. But these bonds are backed by the full faith and credit of the U.S. government, which is still considered a safe investment by investors all over the world.
Although Social Security gets most of its income from payroll taxes, a smaller share comes from interest and some income tax revenues paid by the affluent on their Social Security benefits. (See Chapter 13 for a discussion of income taxes and Social Security.)
A CHANGING OUTLOOK
Large as the trust funds are, they’re going to shrink rapidly in the future. Today, more than 47 million Americans are age 65 and older. Does that sound like a lot of older people? Just wait. That number will soar beyond 80 million in the coming decades, bringing vastly higher demand for Social Security benefits. Today, there are 2.8 workers for each person getting Social Security. But by 2034 just 2.2 workers will support each beneficiary, and revenue no longer will be sufficient to fully pay for promised benefits, meaning that revenue won’t be able to keep up with benefits. The pay-as-you-go approach will come under increasing pressure, with proportionately fewer workers to support a great many beneficiaries. The