Whether you realize it or not, Social Security is an indispensable program for our nation's retired workers. Though not an entitlement, Social Security provides a benefit to a majority of senior citizens each month. In fact, according to data from the Social Security Administration, it accounts for at least half of all take-home income for 62% of retired workers.
Social Security has its fair share of surprises
However, Social Security is also full of surprises -- some of which aren't of the good variety.
For example, some folks may not be aware of the trouble that awaits Social Security in the years that lie ahead. The latest annual report from the Social Security Board of Trustees estimates that the program will expend more than it collects in income this year for the first time in 36 years. Then, beginning in 2020, this net cash outflow will really begin to accelerate with each passing year. By 2034, the entirety of the program's asset reserves (we're talking about nearly $2.9 trillion in excess cash) could be gone.
The upside to this doom-and-gloom outlook is that Social Security is in no danger of disappearing for current or future retirees. As long as Congress leaves its two recurring sources of income intact -- the 12.4% payroll tax on earned income and the taxation of benefits -- it'll continue to collect revenue that'll find its way to eligible beneficiaries. Of course, this net cash outflow also signals that benefit cuts are a real possibility between now and the next 16 years.
You'll probably owe tax on a portion of your Social Security benefit
Another surprise, which was just alluded to, is that Social Security benefits may indeed be taxable. Last year, $37.9 billion of the $996.6 billion collected by the program was derived from the taxation of Social Security benefits.
The taxation of benefits was just one of many changes passed in the Amendments of 1983 and implemented the following year. For single taxpayers whose adjusted gross income (AGI) plus one-half of benefits exceeds $25,000 (or $32,000 for couples filing jointly), up to half of their benefits could be exposed to federal ordinary income tax rates. The income thresholds tied to this tax have never been adjusted for inflation.
In 1993, under the Clinton administration, a second tier of taxation was added that allowed the federal government to tax up to 85% of a person's or couple's benefits. The threshold in this instance is an AGI plus one-half of benefits of $34,000 for a single filer or $44,000 for a couple filing jointly. These thresholds have also never been adjusted for inflation.
Over time, a tax that was introduced in 1983 and only expected to impact about 1 in 10 senior households now affects an estimated 56% of senior households, per The Senior Citizens League.
Middle-class beneficiaries in this state won't owe as much Social Security tax next year
And just to make matters worse, there's a chance the state you live in may tax you, too.
Although 37 states don't collect tax on Social Security, 13 states do tax benefits, depending on your income level. Some states, like West Virginia and Vermont, mirror the federal tax schedule for Social Security benefits. Meanwhile, states like Missouri offer generous exemptions. In Missouri, single taxpayers and couples filing jointly are exempted from paying tax on their benefits to the state if their AGIs are less than $85,000 and $100,000, respectively.
Beginning in 2019, following legislation that was passed by the state in 2017, residents of Connecticut who are receiving a Social Security benefit are less likely to owe any tax on their payout. In 2018, single Connecticut beneficiaries with AGIs of more than $50,000 and couples filing jointly with over $60,000 in AGI will owe some tax on their Social Security benefits to their home state. But in 2019, the income thresholds at which taxation begins will rise to $75,000 for single beneficiaries and $100,000 for couples filing jointly. This is noteworthy, since Connecticut has one of the highest median household incomes in the country, and it should result in middle-income seniors and families owing less (if any) Social Security tax to the state.
Though adjustments to state income thresholds for Social Security taxation are uncommon, they're not unheard of. Back in 2014, Iowa completely phased out the taxation of Social Security benefits, and there's hope that some of the remaining 13 states may one day follow suit.
In sum, Connecticut is less than six weeks away from becoming a bit more retirement friendly.