Though it has a simple purpose, Social Security is a seriously complex government program. In fact, if you were to attempt to read up on all of its rules, you could spend days on the project -- and still not understand all the nuances. And while some of Social Security's many rules work to seniors' benefit, others will strike you as just plain unfair. Here are three you should know about.
1. Higher earners don't pay Social Security taxes on all of their wages
Social Security is primarily funded by the payroll taxes that every U.S. worker pays on their wages, but higher earners don't pay those taxes on all that they earn. A wage cap limits the extent to which earnings are subject to the payroll tax. Currently, that cap sits at $137,700, but come 2021, it will increase to $142,800. So higher earners could conceivably get out of paying Social Security taxes on the bulk of their income, while lower earners are guaranteed to pay taxes on all of their earnings.
Consider someone who makes $300,000 a year. That person pays Social Security taxes on less than half of his income, while someone earning $60,000 a year pays those taxes on every dollar he makes.
Many lawmakers have long argued that this structure is both regressive and bad for the health of the benefits program. Without the wage cap, it would collect hundreds of billions of dollars more in taxes each year from the wealthiest Americans -- money that would keep it solvent, and help prevent benefits cuts from becoming unavoidable in a few years.
President-elect Joe Biden plans to propose that Social Security taxes be extended to cover earnings over $400,000. But he would need the support of Congress to implement such a change.
2. COLAs aren't based on senior-specific expenses
Social Security's annual cost-of-living adjustments, or COLAs, are based on increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W measures price changes for a basket of goods and services in an attempt to gauge how inflation affects real people. But the contents of that basket don't reflect the way that seniors spend their money.
For example, fuel prices play a large role in determining the CPI-W, but many retirees don't drive very much, and therefore don't buy much gasoline. What they do spend a lot on is healthcare, which is under-weighted in the CPI-W. And it's no secret that the growth of U.S. healthcare costs has long been outpacing the core inflation rate.
Some lawmakers have been pushing for a change that would base future Social Security COLAs on the Consumer Price Index for the Elderly (CPI-E), an index that more accurately measures the growth of retiree-specific expenses. But again, it looks like that would require bipartisan buy-in from Congress, so there's no guarantee it will happen.
3. Even moderate-income seniors will have to pay taxes on their benefits
Seniors who get all of their income, or the vast majority of it, from Social Security generally don't pay taxes on their benefits. But moderate earners can land in a very different boat.
Whether a senior's Social Security benefits are taxed or not depends on their provisional income, which is calculated by taking half of their annual benefit and adding in all other income that person collects. Single tax-filers with a provisional income of $25,000 to $34,000 can be taxed on up to 50% of their benefits, and the same holds true for married couples filing joint tax returns with a provisional income of $32,000 to $44,000. Meanwhile, singles with a provisional income above $34,000 will pay taxes on up to 85% of their benefits, as will married couples filing jointly with a provisional income above $44,000.
This leaves many moderate-income households in a tough spot during retirement. Worse yet, the thresholds for provisional income have not been adjusted for inflation since they were last changed nearly 30 years ago, despite the fact that $34,000 went a lot further in the early 1990s than it does today.
While many of Social Security's rules help protect seniors, some work to the disadvantage of many. The more you learn about what those are during your working years, the less likely you are to face unpleasant surprises in retirement.