Social Security is a big deal. This year, it's expected that 59 million Americans will collect more than $860 billion in total Social Security benefits -- more than the gross domestic product of Sweden or Argentina. In 2012, nearly a quarter of older Americans relied on Social Security for 90% or more of their household income. It's clearly a vital program, but if you take a close look at it, you'll see that in some ways, it's unfair (or at least seems unfair) to many people -- most likely including you.
Some couples favored
For starters, Social Security favors married people over single people, offering spousal and survivors' benefits that only spouses and surviving spouses can receive. Spouses, for example, can collect benefits based on their own income or their spouse's income -- whichever is higher. Further, married couples with only one wage-earner are favored over two-income couples with similar incomes: Single-income couples get about twice the rate of return on their Social Security contributions. For example, the retirement benefits granted to single people and two-earner couples who were born in 1949 and have average earnings represent an inflation-adjusted annual return of 2%-2.5%. Meanwhile, one-earner couples get an annualized return of more than 4.5% on their contributions. This discrepancy was more innocuous long ago, when most marriages had a single earner, but over the years it has discriminated against more and more couples.
Some retirees are double-taxed
Another unfair aspect of Social Security is that some benefits are taxed thanks to a 1983 law that took effect in 1984 and was intended to help address an anticipated shortfall in Social Security funding. Remember that Social Security is based on a tax to begin with: We pay Federal Insurance Contributions Act taxes out of our paychecks. Thus there's double taxation going on: Our income is taxed when we earn it, and then sometimes again when it's returned to us in the form of Social Security benefits.
The 1983 law didn't allow for the taxation (at your ordinary income tax rate) to be indexed to inflation, so it's been affecting more people more harshly over the years. In a nutshell, if you're single and your earnings top $25,000, or if you're married filing jointly with income of more than $32,000, you may have 50% of your Social Security benefits taxed. For singles earning more than $34,000 and joint filers earning more than $44,000, up to 85% of benefits may be taxed. (Note the marriage penalty here: You might assume that with the threshold for singles set at $25,000, it should be $50,000 for couples, but for joint filers, it's much lower.)
Lower-income workers favored
Lower-income workers get more of their Social Security taxes back as benefits than do higher-income workers. According to the Center on Budget Policy and Priorities: "Benefits for someone who earned about 45 percent of the average wage and then retired at age 65 in 2012 replace about 55% of his or her prior earnings. But benefits for a person who always earned the maximum taxable amount replace only 27% of his or her prior earnings, though they are larger in dollar terms than those for the lower-wage worker." This can certainly seem unfair, but it reflects a "progressive" design, where higher-income people pay more, proportionally, than lower-income folks. Supporters of such systems will point out that wealthier people need these benefits far less than poorer people do.
Higher-income workers favored
That unfair Social Security feature is countered by another one that favors the wealthy. That's because the wealthy pay a smaller percentage of their income in Social Security taxes. To back up a bit, remember that the tax for Social Security on your income is 6.2% apiece for you and your employer, for a total of 12.4%. (Self-employed folks pay the whole tax themselves.) Therefore on a base of $10,000, the tax would amount to $1,240. You might, therefore, expect that someone earning $1,000,000 would be hit with a tax for Social Security of $124,000, right? But you'd be wrong, because the taxable income on which we're all taxed for Social Security is capped -- the limit is $117,000 for 2014 and $118,500 for 2015. So in 2014, the person earning $1 million pays no tax for Social Security on $883,000 of his or her income, while someone squeaking by on $25,000 is taxed on all of it.
Granted, it was once suggested that high-income individuals be excluded from Social Security altogether -- that is, exempt from Social Security taxation and also unable to collect Social Security benefits. But the purpose of Social Security is to provide a financial safety net for those of limited means, and many Americans think the wealthy should contribute to societal welfare.
While the Social Security system is imperfect -- and seemingly unfair in various ways -- it's still a critical social program, quite possibly benefiting more people than any other. It can clearly be improved, though, and reforms have been suggested that would reduce or eliminate real or perceived unfairness -- such as removing the income cap and taxing all of everyone's income. But Social Security is a complicated beast, and it's difficult to say objectively whether or not certain policies are fair. And it remains to be seen whether Americans and their elected officials will support measures to make the program more egalitarian.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any stocks mentioned. Nor does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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