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Home > Investing > Does The Payroll Tax Cut Lower Your SS Benefits?

Does The Payroll Tax Cut Lower Your SS Benefits?

December 28th, 2011 Leave a comment Go to comments

The Congress and the President have passed a two month extension to the payroll tax cut first initiated in 2009. This tax cut reduces the payroll tax rates from 6.2% to 4.2%. The payroll tax is money dedicated to funding Social Security retirement and disability benefits. Most of the money goes towards funding Social Security retirement benefits.

This tax cut will offer the average taxpayer a boost of about $1,000 to their income. Also, since this tax is levied on individual people not on households, your spouse and children will also get the cut as well if they work. The tax cut phases out at about 104K due to a cap in the amount of income that the tax applies to.

Since the tax cut necessarily funds Social Security with less money, does this mean that you future benefits will be reduced? The short answer is NO.

How Social Security Benefits Are Determined

Social Security retirement benefits are calculated by the amount of your earnings, not the taxes your pay. So, it works exactly like a traditional pension account which uses your earnings plus years of service to calculate a retirement benefit. This is in contrast to so called defined contribution accounts, such as 401(k)s and IRA. In these accounts, the amount of money you put in plus the time that is left in and your investment return determines how much money you have available at retirement.

For workers who have been earning money a long time (say 30 or more years), they get a big benefit from this arrangement. Since earnings prior to 1991 were taxed at a lower rate than they are now, they get the same benefit as someone who paid higher taxes today on the same income. All workers today who have been earning money over the last two years get this same benefit since the taxes paid are lower than presumably what future taxpayers will need to pay.

There’s No Free Lunch

You might be thinking, how can benefits not change and yet lower taxes are collected? From an accounting point of view, the U.S Congress is using money from the General Budget to “credit” the Social Security Trust Fund the difference in the missing money that would have been collected from the tax. So from the programs point of view, they didn’t lose any money to pay benefits. This is all largely an accounting device anyway, because the your future benefits aren’t funded by savings anyway. They are funded the same way current benefits are funded: using current payroll tax collections.

How To Calculate Your Benefit

If you are interested in calculating your future benefit go to the SSA.GOV site, they have many calculators plus a retirement estimator that uses your exact earnings history. To give you an idea what this looks like I used one of the simple calculators to estimate a benefit off of a simple earnings history:

From this earnings history, this is the estimated earnings benefit:

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  1. December 29th, 2011 at 19:36 | #1

    Very nicely explained SFI! I just hope we are still solvent by the time it is time for me to claim social security!

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