People like Social Security. Along with Medicare it is one of the few programs that Americans support almost overwhelmingly, with an 85% approval rating.
People like paying Social Security taxes less.
The Social Security tax is part of the Federal Insurance Contributions Act tax, or FICA. It is also known as the Old Age, Survivors and Disability Insurance tax. It helps pay for the Social Security program, which issues payments to all Americans when they either reach retirement age or become legally disabled.
What Is the Social Security Tax?
The FICA tax is a payroll tax, which means that employers withhold it directly from their employee’s paychecks. It pays for the major federal insurance programs, Social Security and Medicare. The FICA tax has two components:
- Social Security – 12.4%
- Medicare – 2.9%
There is a third component for individuals who make more than $200,000 as a single filer or $250,000 as joint filers. For these households, the government also includes a 0.9% additional Medicare tax.
The Social Security tax is then broken into two components: employee and employer contributions. Each employer is required to pay half of an employee’s FICA taxes, and to withhold the other half from the employee’s paycheck. This means that as an employee, you pay the following:
- Social Security – 6.2%
- Medicare – 1.45%
Maximum Taxable Earnings
The Social Security tax is an income-capped flat tax. It applies to all earned income up to the maximum taxable earnings. The maximum taxable earnings amount is adjusted upward every year to reflect inflation. In 2019, it is $132,900.
This means that you pay 6.2% in Social Security taxes on earnings no matter how small. Unlike the federal income tax, this is not phased in as your income grows nor is there a minimum amount you have to earn before being subject to taxation. However, the tax only applies to income up to the cap, after which the government does not apply it to any additional income.
As a result, the maximum amount that someone can pay in Social Security tax is $8,239 (6.2% of $132,900.)
This has led many people to call the Social Security tax a regressive policy, because an individual’s effective tax rate actually can go down as they earn more. For example, take two hypothetical taxpayers. One makes $50,000 a year, the other makes $250,000 a year. While they both pay a statutory 6.2% in Social Security taxes, because of maximum taxable earnings their effective tax rates are different:
- At $50,000 per year, the first person pays $3,100 in Social Security taxes over the year. His effective Social Security tax is 6.2% of his total income.
- At $250,000 per year, the second person only pays Social Security taxes on the first $132,900 of her earnings and nothing on the remaining $117,100. She pays the maximum $8,239, making her effective Social Security tax only 3.2% of her total income.
While this used to be true of all FICA taxes, it now only applies to the Social Security tax. The Medicare tax now applies to all earnings.
The Self Employment Tax
Self-employed workers also pay the Social Security tax. However since they don’t have an employer, they have to pay both halves of the tax. This results in a total 12.4% flat tax on all income up to the maximum taxable earnings.
The same is true for Medicare taxes. A self-employed person has to pay both halves of the Medicare tax as well, resulting in a 2.9% flat tax on all income.
This is called the “self-employment tax.” Self-employed taxpayers can claim half of what they pay in self-employment tax as an income tax deduction.
What Does the Social Security Tax Pay For?
The Social Security tax funds the Social Security program, otherwise known as the Old Age, Survivors and Disability Insurance program.
This program provides a fixed income for certain vulnerable populations. Most notably this provides a retirement fund for people of retirement age. However in addition the Social Security program also provides benefits for people with certain disabilities, and for some widows and widowers.
While the federal income tax goes into a general fund which can be spent however Congress deems fit, the Social Security tax is a dedicated tax. Its revenue can only be spent to distribute benefits under the Social Security program.
Social Security Is Pay-As-You-Go
Any excess money that the Social Security tax generates beyond what is needed to pay benefits goes into the program’s trust fund. Congress cannot spend this money for any purpose other than the Social Security program.
This has created some confusion. Many people believe that Social Security works similarly to a retirement fund. They paid the Social Security tax during their working years, and upon retirement are entitled to the benefits.
This has never been the case. Social Security does not set aside money to distribute later unless it runs overages. It pays all benefits with the taxes that current workers pay into it today. In the years to come, when those workers retire, new tax payments will fund their own Social Security payments.
In part, this is because generally, retirees collect far more from the Social Security program than they pay into it. While estimates vary, many economists suggest that the average retiree collects anywhere from $1.50 to $7 for every $1 paid in Social Security taxes during their working years.