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Getting Squeezed

Marjorie Kondrack

MY CONTENTION: ONE of the most egregious parts of the tax code is the stealth tax on Social Security benefits.

To be sure, if your income is low enough, your benefits won’t be taxed. But around 56% of retired Americans pay taxes on up to 85% of their Social Security benefits. And the number grows each year. Incomes rise, if only because of inflation-driven increases, and yet the thresholds for taxing benefits have never been adjusted for inflation or wage growth. Adding insult to injury, 11 states currently tax Social Security benefits.

Today, if you’re an individual filer with a combined income between $25,000 and $34,000, up to half of your Social Security benefit will be taxable on your federal tax return. If your combined income is above $34,000, up to 85% of your benefits may be taxed.

Meanwhile, if you’re married filing jointly and have a combined income of $32,000 to $44,000, up to half of your benefits will be taxable. If your combined income is above $44,000, up to 85% will be taxed. Combined income includes your adjusted gross income, municipal bond interest and half of your Social Security benefit. Who came up with that cockamamie definition of income?

When the tax on benefits was introduced in 1984, it only applied to 50% of benefits. Because of further tax hikes introduced in 1993, up to 85% of benefits can now be taxable. So, let me get this right: No tax was fair before 1984, taxing 50% was fair for the next decade and now 85% is justified. Makes total sense, right?

Apparently, ignoring inflation is also fair. The $25,000 threshold for individuals and $32,000 for joint filers would rise to $73,000 and $93,200, respectively, if they were adjusted for the inflation since 1984, according to a USA Today article. Result: A tax, which once hit just 10% of retirees, now affects more than half of seniors. When you consider that other tax items—such as federal tax brackets, contributions to retirement accounts and the standard deduction—are adjusted annually, it all seems ridiculous.

Currently, there are bills in Congress called You Earned it, You Keep It and The Senior Citizens Tax Elimination Act, written by a Democrat and a Republican, respectively. Both would remove Social Security benefits from the calculation of gross earnings for income tax purposes.

But don’t expect either bill to be acted upon, given Social Security’s looming funding crisis. Remember, we’re looking at potential Social Security cuts of 25% in the early 2030s if Congress doesn’t take action. Overhauling Social Security would require bipartisan support. With a divided Congress, there seems little hope.

Meanwhile, seniors are getting squeezed by inflation. Yes, Social Security’s cost-of-living adjustment (COLA) for 2023 was the highest since 1981. Problem is, there’s a weakness in the COLA, which is measured by a version of the Consumer Price Index known as CPI-W. It doesn’t accurately reflect the different spending habits of seniors. A study by The Senior Citizens League, a nonpartisan advocacy group, found sharp cost increases for seniors since early 2000:

  • Out-of-pocket prescription drug costs climbed an average 311%, from $1,102 to $4,524.
  • Out-of-pocket dental care costs rose an average 275%, from $286 to $1,073.
  • Monthly Medicare Part B premiums increased 262%, from $45.50 to $164.90.

The Senior Citizens League found that the goods and services bought by the typical retiree rose 141% over this period, while Social Security benefits climbed just 78%. And don’t expect relief anytime soon. Social Security’s COLA adjustment for 2024 won’t be anywhere near this year’s 8.7%. In fact, the COLA for 2024 could be below 3%.

Inflation hit a 40-year high in June 2022, but it’s now easing in some categories. Still, groceries are continuing to see rapid price increases. Middle- and lower-income retirees—whose budgets are already stretched—will be hit hard, spending more on necessities while losing more of their Social Security benefits to taxes. The bottom line: Even without actual cuts, benefits are shrinking.

Marjorie Kondrack loves music, dancing and the arts, and is a former amateur ice dancer accredited by the United States Figure Skating Association. In retirement, she worked for eight years as a tax preparer for the IRS’s VITA and TCE programs. Check out Marjorie’s earlier articles.

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Mark Gutfreund
1 year ago

I have been on Social Security for almost three years and I certainly don’t enjoy paying taxes, but I think that the amount of tax collected is probably minimal for MOST people. Let me give three examples. Let’s assume a married couple filing jointly. I will give them a combined SS income of $60,000. In a Google search, an average figure for a couple both on SS was $33,000/yr. Standard Deduction for a couple both over 65 in 2022 was $28,700. We further assume that 3 couples will withdraw the following amounts from their traditional IRA’s: $10,000, 20,000, and 30,000. If these couples were using the 4% “rule” for withdrawals, that would represent portfolios of 250,000, 500,000, and 750,000 respectively, again above average. I used the website CalcXML to calculate each couple’s SS which was taxable.

1. $60,000 + 10,000 IRA 
Taxable SS: $4,000
Taxable income: $14,000. This is about half of the standard deduction so this couple could make some Roth conversions without any tax liability.

2. 60,000 + 20,000 IRA 
Taxable SS: $11,100
Taxable income: $31100. This is just a bit over the standard deduction, so tax is only $240, for an effective tax rate of .3%.

3. 60,000 + 30,000
Taxable SS: $19,600
Taxable income: $49,600
Tax liability: $2,097 for an effective tax rate of 2.3%.

I have made assumptions for SS income and IRA withdrawals that are probably above average – except perhaps for many Humble Dollar readers – but even for a couple making $90,000 a year, the effective tax rate is still quite low. That 85% sounds bad until you do the complicated governmental calculations behind the scene.

Thomas Andrews
1 year ago
Reply to  Mark Gutfreund

Mark – good examples. That must have taken more than a few minutes. Thanks for adding this to the discussion.

David Lamb
1 year ago

I don’t understand this:”But don’t expect either bill to be acted upon, given Social Security’s looming funding crisis.” What does the tax on SS benefits have to do with its funding?

Jonathan Clements
Admin
1 year ago
Reply to  David Lamb

If the thresholds for the taxation of Social Security benefits were adjusted for inflation, it would mean less tax revenue to support the program, making the funding crisis even worse.

David Lamb
1 year ago

Really? Even though no general tax receipts – by law – go to SS?

Ian MacLean
1 year ago

You could say that, but it’s funded pretty directly through the payroll tax, and the tax receipts only pay for interest & basic tithing to the military-industrial complex. Moreover, it’s been pretty well demonstrated over the past few decades that higher tax receipts go, the more federal government deficit spends. One famous study found that for every additional $1 received by the Feds, they will spend an additional $1.52. I suspect that number’s gotten worse the proceeding years.

David Lamb
1 year ago
Reply to  Ian MacLean

Yeah, I’m more or less with you, Ian. The SS trust fund from which SS benefits are paid receives no general tax revenue receipts. The looming SS insolvency crisis is what it is independent of what tinkering Congress does to income tax.

Jonathan Clements
Admin
1 year ago
Reply to  David Lamb
David Lamb
1 year ago

Very interesting – did not know that. Thanks. So the argument about inflation indexing rages on.

And elsewhere on HD today I read that QCD annual limitations will be indexed to inflation staring in 2024. Some uniformity would be nice but here we are…

Paul Trayers
1 year ago

I must agree mar’jorie. The numbers do not support the claims.
I’m considering a 15/20k ElonMusk semi-mobile homes supported by WWIIs intercontinental Hwy system. Some might give it some consideration.
The back roads are both wonderous & delightful.

Harold Tynes
1 year ago

I look at the taxation of social security benefits as another reason to delay taking SS until age 70. Also look hard at Roth conversions before age 70 to minimize RMDs. It may be unfair but that is our world.

Marjorie Kondrack
1 year ago
Reply to  Harold Tynes

Two very good strategies to make your taxable portfolio taxable efficient. Thank you, Harold

Andrew Forsythe
1 year ago

Marjorie,

Thank you for a very informative article, which also produced some good comments. As retirees, my wife and I now happily benefit from SS, but your article showed me just how little I know about its legislative history and rationales.

One thing I do know is that Congress will soon need to do the near impossible—show some political courage—and fix SS before it goes broke.

Marjorie Kondrack
1 year ago

Andrew, you comment about fixing social security is of primary importance and I think we are all hopeful that it can be accomplished sooner than later. I think you and Jonathan should be on that advisory committee. Marjorie

stelea99
1 year ago

Most of us have forgotten what happened to Social Security financing in 1983. We focus on the income tax portion. 30 years is a long time. So, it would probably be helpful in trying to understand what was done then and why, so that we can consider what more needs to be done now to keep the system functioning. This paper from SSA can help with this:
https://www.ssa.gov/policy/docs/ssb/v46n7/v46n7p3.pdf

To save you some time, there is a short summary at the beginning of this paper:

“This article traces the legislative history of the new law from
the report, on January 20, 1983, of the recommendations of the
National Commission on Social Security Reform (which
formed the basis of this legislation) to enactment, on April 20,
1983, of Public Law 98-21. It also analyzes the provisions of
Public Law 98-21, which, among other things, delay the annu-
al cost-of-living adjustments in benefits from July to January
of each year, make up to one-half of the benefits received by
higher-income beneficiaries subject to income taxes, gradually
raise the retirement age early in the next century, call for the
earlier implementation of scheduled payroll tax increases, and
put new Federal employees under the Social Security program.
The legislation also establishes a new system of prospective
payment for hospital services under Medicare and extends
suplementary unemployment compensation benefits that other-
wise would have expired in March 1983.”

Demographic changes continue with fewer workers supporting each retired person each year. So if we change the current rules to fix the perceived tax inequity, the trust will run out of funds sooner than projected. More dollars are needed to be able to pay existing benefits into the future. From where should these dollars come?

David Lancaster
1 year ago
Reply to  stelea99

I have read that the gradual increase in the full retirement age instituted in 1983 was also in effect a benefit cut as well.

Jonathan Clements
Admin
1 year ago
Reply to  stelea99

As I’ve mentioned in articles before, and as you’ve suggested, this is ultimately a demographic problem. We need to find some way to avoid having too few workers and too many retirees.

https://humbledollar.com/2022/12/late-shift/

Solutions include increasing immigration and encouraging older folks to stay in the workforce for longer. Raising the eligibility age for Social Security makes a ton of sense, but that change should be geared toward those under age 50, so they have a chance to adapt — and hence it won’t help with Social Security’s short-term funding issue. Perhaps the smartest short-term change we could make is to ease the tax burden on those 65 and up with earned income, so they have an incentive to stay in the workforce for longer. The resulting tax revenue gained would, I suspect, be far greater than the tax lost to those tax cuts.

Lis7
1 year ago

“Raising the eligibility age for Social Security makes a ton of sense”

I know this is an old post, but I can’t let this comment go without a counter to it. I see this argument made a lot, but the fact remains that age discrimination by employers is still a very real issue. Automated job application systems make it very easy for hiring managers to screen out older workers. Consulting and freelancing are not solutions either, because that type of work is often sporadic, and while age may not be an issue at the beginning, eventually it becomes harder to hide. As to getting back into a company, employers are often reluctant to hire someone who has not been recently employed in a traditional office setting. Adding insult to injury is that the self-employed are paying the FICA tax both as an individual, and also the employer’s portion, depressing net earnings and depressing the extra savings needed if the retirement age is raised. Finally, there are biases that are very difficult to overcome – one of the worst ones being the perceived ability to use technology. I hear older people say things like, “oh, I don’t understand technology, so I let my [daughter/son/grandson/niece/etc.] do it”. My theory is that in many cases this is a fear/lack of confidence issue, not an innate ability to learn or teach oneself issue. However, regardless of the cause, it contributes to the perception that all people past a certain age have the same problem. Jmo.

Last edited 1 year ago by Lis7
mytimetotravel
1 year ago

One piece of good news. If the law survives, seniors will not pay anything for drugs once they reach catastrophic coverage next year, and their drug costs will be capped at $2,000 in 2025.

Marjorie Kondrack
1 year ago
Reply to  mytimetotravel

Very noteworthy, Kathy. Something we are all looking forward to.

Jo Bo
1 year ago

You certainly make some good points, Marjorie, regarding inflation, and I can sense your frustration. Perhaps thinking of Social Security benefits as the result of tax sheltered, pre-tax funds accumulating from worker paychecks is less frustrating. That’s how I rationalize the tax consequences.

Even considering employer contributions, the benefits payout rate of Social Security is generous compared to employer-sponsored 403b annuities. I know because I contributed to one over approximately the same years as for Social Security. And every penny of annuity benefit is taxable, just as it is for traditional IRAs.

Marjorie Kondrack
1 year ago
Reply to  Jo Bo

Thank you, Jo Bo. I agree that Social Security is a life saver for so many. I have seen a lot of seniors who are just living on the fringe, during my volunteer tax years and it is frustrating to see them being pushed into a bracket where their benefits are taxed. For them,a 3% COLA just won’t cut it. The majority in this category were women who are widows or divorcees.

R Quinn
1 year ago

Majorie, your views expressed here reflect the way many of us seniors feel, probably most. Even though I can speak as a fully qualified senior (seasoned) I disagree with this general point of view.

Generally speaking we seniors had forty or more years to prepare for retirement including knowing that inflation would be a part of our lives.

In 2023 federal spending on Social Security and Medicare alone equal 33% of the budget. Six times more than we spend on education, training, employment and social services. How can we seniors claim to be entitled to more?

I don’t like paying taxes and I sure don’t like IRMAA, but paying income tax on up to 85% of our SS benefits is based on the fact that overall we seniors fund only about 15% of total benefits we receive as a group.

For myself and my wife I long ago collected twice what I and my employers paid in payroll taxes over fifty years. We may have earned our benefits through years of working and meeting the requirements of the law, but we sure didn’t pay for them.

Income taxes on SS benefits send $49 billion a year to the SS trust and $33 billion to Medicare trust. Without that, taxes would be higher or the trusts in worse shape than they currently are.

We Americans are a strange lot, we complain about taxes all our lives and try to avoid or defer them – 401l, Roth account for example and then when we reach our golden years, we as a group seem to want more to which we are “entitled.”

The way I see it, we had our shot and it is unfair for we older Americans to demand more which results in taking from younger Americans, young families struggle as much as and perhaps more than seniors. Younger Americans are now paying for our benefits and if Congress ever fixes SS and Medicare – which they will – workers will likely pay much more in taxes.

I am not a great fan of the SSL because I think they mislead and use flawed surveys. However, the CPI-W may not be perfect, but no measure will be because each of us has their own CPI based on our spending patterns. For example, if a senior is renting their rent may increase, but if they own a home only taxes may increase, but even that is tenuous. In NJ a senior citizen couple earning up to $190,000 can have all property taxes frozen so they do not pay increases, but someone else does. Other states have similar programs.

In any case, using the CPI-E is not a solution either as in some years past it resulted in a lower COLA or very minimal difference.

My bottom line is that we are all on this journey together, each age group has its needs and desires along the way and no one group has the right to take from the other thereby making their journey more difficult.

Last edited 1 year ago by R Quinn
Thomas Andrews
1 year ago
Reply to  R Quinn

Dick, good points and perspective overall. However, the comment about having received over twice what you and your employer contributed doesn’t take into account what those contributions would be worth today had they been invested and the returns compounded.

Randy Dobkin
1 year ago
Reply to  R Quinn

In your calculations of payroll taxes you paid vs. benefits received, have you adjusted for inflation?

R Quinn
1 year ago
Reply to  Randy Dobkin

Well, I paid 1959 taxes in 1959 dollars and 1999 taxes in 1999 dollars and receive benefits in 2023 dollars.

mytimetotravel
1 year ago
Reply to  R Quinn

This does not address Marjorie’s point that the thresholds have never been adjusted for inflation. If $25,000 was considered a fair threshold in 1984, how can it still be considered fair in 2023?

R Quinn
1 year ago
Reply to  mytimetotravel

The law was put in effect purposely not adjusting for inflation. The point is that we are only being taxed for something we did not pay for. This is really no different than an employer funded pension or an annuity purchased with pre-tax savings.

The problem is the way the payroll tax is structured it creates the impression we are self-funding our SS and we do not. The really fair way to tax the benefit is to not tax amounts up to what we as individuals paid in payroll taxes and then everyone pays taxes on the balance. But there is a hitch there too.

Many people think their SS benefit is based on the taxes they paid. Fact is there is no connection between taxes paid or not and benefits paid. Benefits are based on the formula in the law, payroll taxes are one of several funding sources. Keep in mind millions of people receive SS benefits never having paid a penny in taxes. Also, benefits can be improved with no change in taxation.

My real point is there are poor, lower income, middle class and upper income at every age group. Poverty is lower for seniors than the working population. Every vicissitude of life happens to all people, regardless of age.

Seniors have a built in COLA, working people have no such guarantee, seniors have Medicare at far less cost than a young family buying health insurance. SS benefit formula is skewed to provide higher relative benefit for lower income workers.

I just struggle with the idea of seniors as a group deserving more special consideration simply because we passed a certain age.

Last edited 1 year ago by R Quinn
mytimetotravel
1 year ago
Reply to  R Quinn

I am well aware that current contributions fund current benefits. That is standard for government pensions. That does not alter the fact that an absolute number should be adjusted for inflation and doing so is not special treatment.

R Quinn
1 year ago
Reply to  mytimetotravel

The absolute number was designed so there would be a gradual increase in taxes. But I think we need to keep in mind just because some of SS is taxable does not mean taxes are paid on that money. Low income people especially those relying primarily on SS pay no or little income tax in any case.

Marjorie Kondrack
1 year ago
Reply to  R Quinn

Good morning Dick. First, my concern is not focused on the financially fortunate. People who are comfortably well off can afford to pay their own way without Social Security or Medicare. However, this group is so small statistically it doesn’t make sense to dismantle a successful system to throw millions of elderly into financial and emotional distress to eliminate the rich.

Second, to your point that we need to spend more money on the next generation and less on the last one—Beating up on the elderly is an unjustifiable and fruitless diversion.
we should enlarge our human investments in housing, education and healthcare for the young. We need not beggar the elderly to do so.

Third, while most of us do plan for the future
you can make all the right moves and still wind up behind the proverbial “eight ball”in circumstances we have no control over.

I have statistics contrary to yours but don’t want to turn this into another article.

your comments are well noted. We must revisit this another time. Regards, Marjorie

Ormode
1 year ago

I read somewhere that 15% of retirees have an income over $100K, and 7% are over $200K. So not all retirees are poor.

In certain parts of the country, the majority of retirees are quite well-off.

mytimetotravel
1 year ago
Reply to  Ormode

Just as there are very wealthy non-seniors, I’m sure there are very wealthy seniors. However, a number of those over $100K seniors are probably in that bracket because they are taking RMDs – money which they saved when they were younger.

parkslope
1 year ago
Reply to  mytimetotravel

I fail to see why it matters if a significant part of the income of some high income seniors comes from their RMDs as opposed to, for example, dividends and capital gains from investments they made when they were younger.

Marjorie Kondrack
1 year ago
Reply to  mytimetotravel

A good observation, Kathy. According to new data from Fidelity Investments, the ranks of so-called 401(k)millionaires are diminishing. The number of accounts with at least $1 million in retirement savings fell 32% to 299,000, from 442,000 due to stock market gyrations.

parkslope
1 year ago

The Fidelity study you cited simply reflects last years (2022) downturn in the stock market. To quote from the Washington Post’s article about the study:

Although fewer people held onto millionaire status year over year, there was a 15 percent bump in 401(k) millionaires in the fourth quarter compared with the preceding three-month period.
“The hope is that they continue to stay on track and, as market conditions improve, more retirement savers should rise above that millionaire threshold,” he said.
https://www.washingtonpost.com/business/2023/02/24/fidelity-inflation-401k-millionaires/

Last edited 1 year ago by parkslope
Marjorie Kondrack
1 year ago
Reply to  parkslope

Thank you for your input—for reading and your up to date knowledgeable comments. Hope it all becomes reality.

Ormode
1 year ago

That is, I believe, a per-account number. How many retirees have more than 1 account? How many have other money in brokerage accounts, savings accounts, businesses, or rental property? The richest retiree I know ($70 million) has hardly anything in his IRA.

mytimetotravel
1 year ago
Reply to  Ormode

From the 2023 Social Security Fact Sheet:

ο Among elderly Social Security beneficiaries, 37% of men and 42% of women receive 50% or more of their income from Social Security. *
ο Among elderly Social Security beneficiaries, 12% of men and 15% of women rely on Social Security for 90% or more of their income. *

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