Social Security, formally known as the Old-Age, Survivors, Disability, and Health Insurance Program (OASDHI), provides retirement income and insurance for eligible workers and their dependents against losses of income because of disability or death. The following benefits are provided: old-age benefits, survivors benefits, and disability benefits. Old-age benefits allows people at least 62 years of age to receive a pension, the amount depending on how much was paid in and what age the pension is started. However, full benefits are only provided if you have reached full retirement age, which ranges from 65 to 67, depending on when you were born. The survivors benefits, which, in the form of a life insurance, is payable to dependent children and the surviving spouse of a deceased worker.
Disability benefits were added in 1956, initially to those between the ages of 50 and 64, but was extended in 1960 to cover all workers who meet eligibility requirements. Becoming totally and permanently disabled is treated as if the eligible worker reached retirement age, qualifying them to a pension that would otherwise only be payable at full retirement.
Medicare was added in 1965, offering taxpayers aged at least 65 and some disabled persons insurance to pay for hospitalization, skilled nursing, hospice care, home health services, and other kinds of medical care. Subsidized medical insurance is also available for doctor services and other expenses that are not covered by the basic plan.
According to the Social Security Administration (SSA), the federal agency that manages Social Security, Social Security provides about 40% of the average wage earner's income during retirement.
All taxpayers are eligible for Social Security and Medicare if they paid employment taxes or self-employment taxes for a certain period, measured as quarters of coverage. One credit is earned for each quarter of coverage (QC) in which the taxpayer has paid the FICA tax (Federal Insurance Contributions Act) on a specified minimum of wages, adjusted annually according to the average total wages of all workers. In 2017, this amount was $1300. The minimum earnings is adjusted annually according to the change to the national average wage index, rounded to the nearest multiple of $10.
Social Security benefits are based on the number of credits earned. In 2017, one credit is earned for every $1300 in earnings, up to a maximum of 4 credits per year. Some benefits are only available to fully insured taxpayers. To achieve fully insured status, the taxpayer must earn at least 40 credits between the ages of 22 and 62, or before disability or death, whichever is earlier. There is also a currently insured status with lower eligibility requirements, and also lower benefits, where at least 6 quarters of coverage during the 13-quarter period ending with the quarter that includes disability, death, or entitlement to retirement benefits.
Survivors benefits depend on the worker being either fully or currently insured, but retirement benefits require that the worker be fully insured. An ex-spouse may also be eligible for benefits based on your earnings if your ex-spouse:
- is at least 60 years old, or 50, if disabled
- has been married to you for at least 10 years; or is caring for a child who is entitled to benefits based on your record
- is not entitled to a benefit based on their own record that is equal or higher than the full insurance amount on your record
- is not currently married, unless the remarriage occurred after age 60, or after age 50, if disabled.
Revenue used to pay for Social Security and Medicare are based on Social Security and Medicare taxes, collectively known as FICA taxes, which are assessed on what the tax code refers to as earned income, income earned from work. Because these taxes are only assessed on working income, they are also called employment taxes or self-employment taxes, depending on whether the worker is an employee or is self-employed. All benefits are adjusted automatically every January according to the Consumer Price Index (CPI), unless Congress legislates a different increase, in which case there will not be an automatic increase for that year.
Social Security and Medicare are financed by taxes on employment and self-employment. In 1935, the tax rate of 1% was assessed on the 1st $3000 of the employee's wages and the employer and employee were liable for the tax up to a $30 annual maximum each. When Medicare was added in 1965, there was a separate hospital insurance tax added which when combined with the Social Security tax, created the FICA tax.
Social Security tax is only assessed on a wage base (officially called the Social Security Contribution and Benefit Base), adjusted annually for inflation. In 2017, the wage base was $127,200. Up until 1993, the Medicare tax applied to the same wage base, but the 1993 Tax Reform Act eliminated the maximum wage base for the Medicare tax.
Nowadays, the Social Security tax is 12.4% on all wages earned up to the wage base limit that is adjusted annually for inflation. The employer pays 6.2% and the employee pays the other 6.2%. The self-employed pays both the employer and employee portion of the tax, but the self-employed can deduct the employer percentage. The Medicare tax is 2.9% of all wages. Like the Social Security tax, the employer and employee each pay ½ of the tax, equal to 1.45% of wages. The self-employed must also pay the Medicare tax on all earned income.
The Patient Protection and Affordable Care Act of 2009, otherwise known as Obamacare, also enacted 2 additional taxes on the wealthy: the 3.8% Medicare surcharge, otherwise known as the net investment income tax, and also an Additional Medicare Tax of 0.9% on earned income: there is no employer match for these taxes. However, the income only applies to taxpayers earning at least $200,000 ($250,000, if married filing jointly). Nonetheless, both these taxes will probably be rescinded by the current Republican administration, as part of their efforts to reduce taxes on the wealthy. These benefits for the wealthy will be paid for by eliminating the tax subsidies paid to low-income Americans under Obamacare and by eliminating the Medicaid expansion for poor people.
Amount of Benefits
The benefit amount depends on the primary insurance amount (PIA), which is the amount payable to a worker who retires at the normal retirement age. It is calculated from the average indexed monthly earnings (AIME) of the taxpayer, adjusted for inflation to current wage levels, which is defined in the law as the 2nd year previous to the year of the start of benefits. (Hereafter, the current year will refer to the 2nd year previous to when benefits are taken, which is the latest year for which the AIME has been compiled.)
The PIA is computed using up to 35 years of earnings, selecting those years with the highest indexed earnings, which are then summed, then the total amount is divided by the number of months in those years, rounding down the result to the next lower dollar amount. The benefit is calculated by including the years when the taxpayer earned the most money. If the taxpayer worked longer than 35 years, then low years can be dropped, resulting in a higher PIA.
The years that must be included when computing the average depends on the individual's age and on the type of benefits requested. If the taxpayer worked insufficient years, then some years of 0 earnings must be included to calculate the average. After dropping years of lower earnings, the total indexed earnings are divided by the number of months used to compute the AIME, which is converted to the PIA by a statutory formula.
The indexed earnings for each year is calculated by calculating an index ratio, by taking the AIME for the current year and dividing it by the AIME for the target year, then multiplying the wages earned by the taxpayer in that year by the index ratio. The indexed wage for each year is calculated accordingly. The PIA is based on this result.
The PIA depends on previous income earned over the relevant years, but different percentages are applied to different amounts of the earnings, what the Social Security Administration calls bend points. The PIA equals the sum of 90% of earnings below the 1st bend point; 32% of the AIME over the 1st bend point but below the 2nd bend point; then 15% for all monthly earnings subject to the Social Security tax over the top bend point. The amount is adjusted to a lower multiple of $0.10, if it is not already at that multiple. For 2017, the 1st bend point was the 1st $885 of the AIME, and the 2nd bend point was at $5336. As can easily be seen from the percentages associated with each bend point, the PIA gives greater benefits to lower income taxpayers.
Social Security also provides a one-time payment of $255 to your spouse or minor children if you die.
Classes of Benefits
There are 3 major types of benefits provided by Social Security: retirement benefits, disability benefits, and survivor's benefits. If a worker retires at full retirement age, then he is entitled to 100% of his PIA. Although benefits can be received starting at age 62, the benefit is reduced by 5/9 of 1% for each month prior to full retirement age. Workers can also delay retirement until age 70½, earning additional credit for each month that retirement is delayed.
Family members may also receive some benefits, limited by a maximum amount, determined by the PIA. The spouse of a retired worker, or the ex-spouse of a worker who have been married at least 10 years, is entitled to 50% of the PIA at full retirement age. Like the worker, the spouse can retire at age 62, but the benefit is reduced by 25/36% for each month prior to full retirement age.
There is also a children's benefit, equal to 50% of the workers PIA. There are several classes of dependent children in regard to benefits:
- unmarried, younger than 18
- unmarried, but who are disabled, provided that they were disabled before age 22
- unmarried children younger than 19 who are full-time students in the secondary school
There is also a mother's or father's benefit: the mother's benefit is payable to the wife of a retired worker and the father's benefit is payable to the husband of a retired worker, if they care for a child under 16 or a disabled child who is receiving a benefit.
The rules for determining the family maximum are complex, having evolved over time, and the rules are different for retirement and survivor benefits from those for disability benefits. Nonetheless, all the rules calculate the family maximum as a percentage of PIA.
The PIA is the basic Social Security benefit before adjustments for retirement age, earnings, and other factors. The family maximum usually varies between 150% and 180% of the worker's PIA.
The family maximum is based on the PIA: the worker's benefit is subtracted from the total benefit amount payable to the family; then the benefits for these other family members, called auxiliaries, are reduced proportionately. The worker's own benefit or of divorced spouses, and surviving spouses, are never reduced. Only the benefits of the auxiliaries are reduced. For retirement and survivor benefits, the family maximum does not reduce the amount of benefit until these family members receive benefits, in which case the auxiliary beneficiaries will still receive at least partial benefits. Families of a disabled worker, however, may lose all auxiliary benefits, even if only one family member qualifies.
There is also a parent's benefit, payable to a deceased worker's parents who were at least 62 years of age if they were dependent on the worker for support at time of death.
For disability benefits, each state has a disability determination service (DDS) that evaluates whether an applicant for disability is disabled as defined under the Social Security Act. If the individual is so certified, the benefits are paid, but only after the worker has been disabled for 5 full calendar months.
Qualification for disability benefits depends on age. Becoming disabled before age 24 will qualify if the worker had 6 quarters of coverage out of the 12 quarters ending when the disability began; for those up to 31, they must have one quarter of coverage for each two quarters beginning at age 21 and ending on the onset of disability; workers over 31 must be fully insured, with at least 20 of the last 40 quarters in covered employment.
To motivate workers to seek employment, the workers are often referred to state vocational rehabilitation agencies for assistance and they are permitted to work for a trial period without losing the benefits. A trial work month is any month where earnings exceed a certain minimum, adjusted annually for inflation, which in 2017, was $810. The worker only loses benefits with at least 9 such months during a rolling 60-month period.
Termination or Reduction of Benefits
There are certain factors that terminate benefits:
- divorce from a person where the divorcee was receiving benefits based on the ex-spouse's PIA
- a child reaching 18 unless the child is in high school, in which case, the benefit terminates at age 19
- when the child reaches 16, then the mother's or father's benefits terminates
Payments are also stopped to a child who is adopted unless the adopter is a stepparent, grandparent, or aunt or uncle.
There are also complex rules with marriage or remarriage. If a dependent or survivor beneficiary marries someone who is not a beneficiary, then the payment stops; if both parties are beneficiaries, then payments may continue.
If Social Security is taken before the full retirement age, then there are 2 limits that may reduce the benefit because of disqualifying income. Disqualifying income includes earnings from work, but does not include pensions and retirement pay, stock dividends, insurance annuities, interest on savings, gratuitous transfers, rental income, or the gain from selling capital assets. For those years not including the year of reaching full retirement age, the benefit will be reduced by $1 for each $2 of disqualifying income over the 1st limit. For the months before full retirement age but in the same year of full retirement, the benefit is reduced by $1 for every $3 earned over the 2nd limit. In 2017, the 1st limit was $16,920, and the 2nd limit was $44,880. After reaching full retirement age, there is no reduction in benefits regardless of income.
However, Social Security benefits may also be taxed if the taxpayer has sufficient income from other sources. For an individual, half the Social Security benefits will be taxable if the income for an individual is between 25,000 and $34,000 (married couple filing jointly: 32,000 to $44,000). Up to 85% of the benefits may be taxed for incomes above these upper ranges. More details about the taxation of Social Security benefits are found in Taxation Of Social Security Benefits and Tier 1 Equivalent Railroad Retirement Benefits. Taxes on Social Security benefits are transferred to the Medicare Hospital Insurance trust fund.
Financial Integrity of Social Security and Medicare
When the Social Security system was being conceived, there was debate on whether it should be funded out of general tax revenues or by specific contributions from employees and employers. That the Social Security system should depend on specific contributions was to give participants a moral right, if not a legal right, to the benefits.
There is also a debate on whether payments should be based on a reserve system or a pay-as-you-go system. The reserve system would've required that workers accumulate funds before they could receive benefits, whereas with the pay-as-you-go system, benefits are paid by current revenues. In other words, current benefits depend on the taxes collected from those still working. The main problem with the pay-as-you-go system is that the number of workers must be high relative to those receiving benefits. Now that the number of people collecting benefits is increasing rapidly while the number of workers is not increasing at the same rate, the Social Security fund will be depleted after a certain number of years. For instance, in 1947, when only retired persons and survivors received benefits, about 1 out of every 70 Americans received Social Security checks. When the program was expanded to include disabled workers and their dependents, and with more beneficiaries receiving benefits over those who were still working, the ratios declined to 3.3 to 1 in 1998 and it is projected that by 2035 the ratio will be 2 to 1. In 2016, about 167 million people worked and paid Social Security taxes and about 59 million people received monthly Social Security benefits. About 42 million of these people were retirees or their families.
The Social Security system has teetered near bankruptcy several times, with Congress enacting higher taxes to compensate for the shortfall. Large tax increases were enacted in 1977, 1988, and 1990. Moreover, the normal retirement age was extended up to 67 years of age, depending on when the taxpayer was born, and also some Social Security benefits were starting to be taxed for people with higher incomes.
Year of Birth: Full Retirement Age
- 1943-1954: 66
- 1955: 66, 2 months
- 1956: 66, 4 months
- 1957: 66, 6 months
- 1958: 66, 8 months
- 1959: 66, 10 months
- 1960 or later: 67
To increase financial soundness, taxes were increased so that the revenues exceeded expenditures, resulting in surpluses that could provide a cushion for future benefits. However, surpluses are expected to decline by 2021 and are projected to be exhausted 2033, although these dates will no doubt change frequently as revenues and expenditures are actualized.
Proposals for Financing Benefits
There have been many proposals to change the way the system is financed. One proposal is to increase the tax base so that people at all income levels pay the Social Security tax. For now, Social Security taxes are assessed only on the wage base. In 2017, this wage base was $127,200. Other people maintain that the tax rate should be increased. Considering that tax rates are already very high, especially for low income taxpayers, and considering that there are no deductions for employment taxes, increasing the tax rate would cause undue hardship on poor people. In fact, as a regressive tax, the burden of the tax would be inversely proportional to the income of the taxpayer. Because of this, it is better to finance Social Security and Medicare through a progressive income tax rather than as a separate tax, since more of the burden would fall on wealthier people who could more easily afford it.
There are also proposals for changes in the benefit levels. Some have argued that only a minimum should be paid to maintain a minimal standard of living. Another proposal, which has already been implemented, and which will almost certainly be extended in the future is increasing the retirement age. This will be a necessary adjustment because people will be living longer, especially as medical technology develops. Another proposal is to reduce the annual adjustment for inflation increases. Currently, the inflation adjustment changes are based on the CPI, which overstates the actual increase in prices for consumers, because the CPI does not account for how consumers change their buying patterns to reduce their expenses. The so-called chained CPI does account for changes in buying patterns, resulting in a lower cost-of-living adjustments (COLA) that reflects actual increases in expenditures.
Another major option for financing Social Security is by privatizing it: using the funds to invest in the stock market or other financial markets so that a higher rate of return can be earned on the contributions. Some people have estimated that the cost of financing Social Security would decrease by up to 80%. However, a privatized system would take time to develop, so there would necessarily be a transition period. Moreover, the fund would be subject to considerable investment risk.