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You betcha, but also necessary – unless you have a better idea to generate income for the Social Security and Medicare trusts.
You and I did not pay for our Social Security benefits. In the aggregate all beneficiaries have paid for about 15% of benefits received. I did not contribute toward my pension so it’s fully taxable. If I had contributed on an after-tax basis that portion would not be taxed.
I looked at the total I paid in FICA taxes as well as what my employers paid from 1959 until I retired in 2010. We received in SS benefits, including my wife’s benefit on my earnings, all I and my employers paid in taxes within about six years of starting Social Security payments.
As with most government programs there is much confusion. Some people think they will pay 50% of their benefits in taxes. Of course the reality is that while a portion of the SS benefit may be taxable income, what is actually paid in taxes depends on a persons overall tax situation and income tax bracket.
Critics note that the income point at which SS becomes taxable is not indexed for inflation. That’s true, but by design presumably so revenue increases over the years.
The taxability of SS benefits can be minimized if retirement income is virtually all from Roth accounts which does not count in the Modified Adjusted Gross Income calculation – now, in my opinion that is unfair. Income in retirement is income after all.
The bottom line is the taxability of up to 85% of a Social Security payment is a important funding source for both the SS and Medicare trusts. The SS trust receives $50 billion a year from the taxation of benefits and the Medicare trust $35 billon a year.
Both the Social Security and Medicare trusts need additional revenue which will require higher taxes or benefit changes. Eliminating the taxability of SS benefits means more of the needed revenue must come from working Americans and future retirees.
“Beneficiaries pay only 15% of benefits received” is VERY misleading. Payments are made 20, 30, or 40 years prior to receiving benefits A $1 payment would grow to about $5 in 40 years at a rate of just 4%
It’s insurance, not an investment and it provides a wide range of benefits well beyond what may be received by the worker paying taxes.
I don’t think that fair has much to do with it. No matter how you address the SS funding shortfall, some will do better than others with regard to how much they get out vs how much they put in.
In this situation there are no solutions, only tradeoffs.
I view taxing SS benefits as a form of means testing, and I don’t have a problem with that. I also agree with Quinn’s point that Roth IRAs are a form of means and should be included in MAGI calculations.
Unfortunately, a lot more needs to be done to fix the SS shortfall as the SS trust fund is expected to be depleted by 2033 and FICA payroll taxes will not be enough to cover SS costs. Alot more pain to go around.
As far as investing SS trust funds in the stock market. I see multiple problems. First the trust fund is being depleted and will be empty in 10years – i.e. this is effectively shorter-term money. So investing in equities would take on significant risk. Another is that the trust fund money is not sitting in cash somewhere to be easily redeployed. They are bonds that would have to be redeemed from the Treasury. Where would the treasury get the cash for that? Finally, and most importantly, investing the trust fund in equities makes the US govt an investor with a say in how companies run their businesses’. Does anyone think that politicians would not use that leverage to try and influence how companies conduct their business. Count me in as a hard no on that front.
The bonds are being redeemed now to pay full benefits. Presumably the feds issue new debt to cover the cash. The sad thing is there’s a combination of relatively minor and painless changes that can be made to make the program solvent for next 75 years.
And that’s exactly what riles me. Why must the politicians wait until the fix is no longer simple!
Excellent point and there is no excuse, but they are afraid to tell voters the truth.
Read the Trustee reports going back at least 15 years. They all contain warnings and urge Congress to act sooner than later and all are ignored.
Couple of points: At the moment, Roth distributions are not included in the formula to compute taxation of Social Security. Also, at the moment, something less than 15% of total retirement account balances are Roth; it would not surprise me in the least if, as the amount in Roth accounts grows, this particular “sweetner” to encourage workers to use Roths disappears at some point in the (not too distant) future.
As for investing SS “trust fund” revenue in the stock market, we already have a pretty good idea of how that might play out, as several states and local governments are allowed to invest their pension fund assets in financial markets. As it turns out, this apparently doesn’t work out too well most of the time, as there are a good many funds that are now promising far more in benefits than they can be expected to reasonably deliver. Besides, would the folks who allowed part of their SS benefit to be used to play the stock market really be willing to take a benefit cut when the market tanks, as in 2008? Sure they would…or not. We all know that Uncle Sam would be on the hook to pay up when the markets go south. So what would be the point?
Under funded government pensions has less to do with market performance and more to do with overly generous benefits and shrinking tax bases.
Underfunded state pensions have all to do with the states not making required contributions as suggested by their actuaries sufficient to fund the benefit promises made. That’s it, not due to stock market performance but politics.
If politicians and the unions in bed with them were honest and actually funded their pension promises when they made said promise, the underfunding problem would go away.
That won’t happen, of course, because then voters would have more information on the cost of the promises.
Very true and especially for state pension systems for teacher plans.
Well, yeah, but there are those who encourage and then justify the under-funding by promoting the obviously mistaken notion that big market returns will make up the shortfall.
So the stock market hasn’t provided good returns?
IMO, it’s not that the stock market can’t provide good returns, for those with the grit and fortitude to stick out the ups and downs. It’s just that, I’ve seen many pension fund managers model their payouts and forward projections on absurdly unrealistic (high) returns. Then a rough patch hits, the fund gets caught in a death spiral, and then taxpayers get stuck with bailing out the fund, all the while leaving the same (irresponsible) managers in charge. I’d hate to see this kind of thing scaled up to the national level; I would like to think that we can keep SS as largely self-funding as we can make it, in order to prevent this kind of nonsense.
When I was working I was on two state task forces to evaluate state pension and benefits.
The pension actuary did its thing looking at the plan, demographics, etc. with n assumed rate of return.
The politicians then did one or two things, The used a higher rate of return or simply did not make the required contributions and the funding fell farther and farther behind.
Sooner or later taxpayers always foot the bill.
In NJ the end solution was to make the state lottery an asset of the pension fund and use proceeds for the funding even though taxpayers were told the lottery was going to benefit children and education in the state. The politicians said that included funding teacher pensions.
Right. That’s pretty much what I said.
Here is an excellent summary of the rules for Roth IRA withdrawals: https://www.schwab.com/ira/roth-ira/withdrawal-rules
For most folks who are over 59.5, and have had their contributions in their Roth for 5 or more years, neither withdrawals from or growth of values inside a Roth are taxable. Therefore, Qualified Roth withdrawals generally are not taxed and have no impact on the taxation of SS benefits.
Unlike a previous Forum discussion on retirement planning, the use of the term Income in the context of this Forum topic refers only to Taxable Income. All uses of the word income are tricky. There is one definition of taxable income for taxation of SS benefits, and yet another for IRMAA Medicare premium surcharges.
To get a better understanding of how SS benefits can be taxed, try the Boglehead Wiki on the subject:
https://www.bogleheads.org/wiki/Taxation_of_Social_Security_benefits
My use of income includes non- taxable income. If I can pay bills or spend the money, it’s income as far as I am concerned. In the case of both taxing SS and IRMAA the income distinctions in the laws are illogical. IMO
I think taxing Roth withdrawals, indirectly in this case, is unfair. Dick, you sound like you have no money in Roth.
If a law is base on the fairness and ability for an individual to afford to pay, it seems to me it should not matter if the income is taxable or not under another law. It is still income. In fact, if that income is tax free, there is a greater ability to pay for things – including taxes on SS benefits and additional Medicare premiums.
Where is the logic in counting municipal bond income tax-free interest as income for SS taxation and IRMAA, but not Roth income? Actually, given the societal benefits of lower interest costs on municipal bonds, there is more logic in ignoring that interest rather than ROTH income for these purposes.
I was already retired when the Roth laws were passed. Later it seemed to me paying conversion taxes upfront and still having to wait five years was too risky. I’ll never know if I made a mistake, but at 80 I’m not starting conversions.
You have a point there. Taxing muni bonds once instead of zero times could be equivalent to taxing Roth money twice instead of just the one time when it’s contributed or converted.
Good job stating both the arguments for and against taxing SS. The bottom line is that someone has got to pay to keep the system working.
Both presidents Clinton and Bush proposed investing some of SS funds in the stock market; What are your thoughts about that?
Can you imagine how much better off people would be had they done that?
Not really, see my reply to Dan
Yes, really. People who invested a portion of their SS when Clinton or Bush was President would be much, much better off today.
My comment “not really” related to the Trust investing in the stock market, not individuals. As far as individuals go, they still couldn’t beat a lifetime with survivor benefits guaranteed income unless everything worked out perfectly an entire lifetime.
My question regarding investments also referred to only the trust. Individual accounts just ain’t how SS works.
But individual accounts is exactly what Bush was proposing.
I thought Bush intended both individual and trust fund investments, perhaps I’m mistaken. At any rate, I never agreed with the idea of individual accounts.
And would have taken vastly more risk….
To be honest I don’t think it is a good idea, too much possible disruption of the markets and added risk. The Committee for a Responsible Federal Budget estimates that such a move would only reduce the funding gap by about 6%
Here is what the CRFB says:
Currently, the Social Security trust fund is invested entirely in non-marketable government bonds. This option would allow the Social Security Administration to replace some of these government bonds with corporate bonds, stocks, and other investment instruments. This option would increase the expected annual return of the trust fund by roughly 8% under our illustrative assumptions, but at the cost of increasing the risk and volitility associated with that return and requring the federal government to issue additional debt to the public to swap for private stocks and bonds.
Note that for illustrative purposes, estimates assume the effects of this option are divided equally between spending and revenue, and estimates were made assuming a nearly solvent system. In reality, neither spending nor revenue would change within the Social Security system. This option would also have a substantially smaller effect if not combined with additional solvency measures.
Like Matt above I have believed that some stock exposure would be a good thing, but I must confess this belief is only my gut feeling.
So let’s pretend that the program were solvent, and with an excess of funds. In that scenario might it make sense for slightly more aggressive investing?