Each month, nearly 63 million people receive a Social Security benefit check, making it arguably the most important social program in America. Of these recipients, an analysis by the Center on Budget and Policy Priorities finds that more than a third are kept out of poverty as a result of this guaranteed monthly payout.
But this payout for eligible beneficiaries has folks asking whether they're getting what they deserve. In other words, taking into account how Social Security is funded, there's the idea that, when you retire, your Social Security income is being taxed twice, thereby reducing your take-home pay.
Is this really the case? Before answering that question, it first really helps to understand how the program is funded.
Understanding how Social Security collects approximately $1 trillion a year
In 2017, Social Security collected $996.6 billion in revenue from three income sources. The bulk of this revenue ($873.6 billion) came from a 12.4% payroll tax on earned income, which, in 2019, ranges between $0.01 and $132,900. What this means is that paid wages of up to $132,900 are hit with a 12.4% payroll tax paid either by you entirely if you're self-employed or split between you and your employer (6.2% each). Any earned income above $132,900 is exempt from the payroll tax.
Another $37.9 billion was generated from the taxation of Social Security benefits for individuals and couples earning over select income thresholds. The first threshold, passed in 1983 and introduced a year later, allows up to half of an individual's benefits to be taxed at ordinary federal rates if their adjusted gross income (AGI), plus one half of their benefits, exceeds $25,000. For couples filing jointly, this figure is over $32,000. A second threshold, passed in 1993, allows up to 85% of an individual's benefits to be taxed if their AGI, plus one-half of their benefits, exceeds $34,000. For couples filing jointly, this figure is more than $44,000.
And finally, $85.1 billion was generated from the interest income on Social Security's asset reserves. The program has built up nearly $2.9 trillion in cash surpluses since 1983, and this surplus is invested in special-issue government bonds that pay interest, as required by law. The almost-2.9% average yield on these bonds led to just over $85 billion in interest income in 2017.
Is my Social Security benefit being taxed twice?
Now that you have a better idea of how Social Security collects money, the question of whether your Social Security income is taxed twice can be answered. And that answer is... maybe, depending on where you live.
The thesis here is that working Americans have had their wages hit with the payroll tax, and then, during retirement, had the federal government once again hit their benefits with a federal tax. Seems like a pretty clear case of double taxation, right? Well, it's not as cut-and-dried as that.
For example, data from The Senior Citizens League finds that 56% of senior households are paying some level of tax on their Social Security income. Conversely, it means that 44% of senior households aren't being taxed on their Social Security income.
Likewise, it assumes that all income collected by the Social Security program is recurring and tax-based. It's not. The $85.1 billion generated in 2017 was the result of interest income on the program's asset reserves. Since there's no way to differentiate exactly which of the three funding sources a Social Security income dollar is derived from, claiming that Social Security income is taxed twice simply doesn't pass muster.
However, in one scenario, it does. If you earn above the income thresholds that trigger taxation at the federal level, and you live in one of the 13 states that also tax Social Security benefits to some varying degree, then, and only then, can your Social Security benefits be described as being taxed twice.
In some instances, it takes a lot of earned income to be taxed at the state level. In Missouri, Rhode Island, Connecticut, and Kansas, individual taxpayers with earned incomes over $85,000, $80,000, $75,000, and $75,000, respectively, are subject to a state-level Social Security tax on their benefits. This excludes a majority of retired workers and ensures that most won't see their benefits taxed twice. They will, however, still owe tax at the federal level.
But in states like Vermont, West Virginia, and North Dakota, which mirror the federal tax schedule for Social Security -- meaning they have the same individual and joint income thresholds of $25,000-plus and $32,000-plus -- it's quite possible your income will be taxed twice.
Ultimately, paying tax on your Social Security benefits is no fun. But being taxed twice is something that thankfully only happens to a small percentage of the population.