A friend who opted to take early Social Security benefits at age 62 last late last year was aghast when he recently found out that half of his benefits might be withheld and 85 percent of his benefits might be subject to taxation. An exploration of why these things are true reveals the true nature of Social Security.

Although Social Security was instituted in 1935 as part of Franklin Roosevelt’s New Deal, most Americans are ignorant of its basic operation and true nature.

There are two parts to Social Security, which is technically the Old-Age, Survivors, and Disability Insurance (OASDI) Program. The Old-Age and Survivors Insurance (OASI) program provides monthly benefits to retired workers, families of retired workers, and survivors of deceased workers. The Disability Insurance (DI) program provides monthly benefits to disabled workers and families of disabled workers.

Social Security is supposedly funded by a 12.4 percent payroll tax (split equally between employers and employees) on the first $142,800 of employee income. Self-employed individuals pay the full 12.4 percent, but receive both a reduction in their net earnings from self-employment and a tax deduction equal to 50 percent of the amount of the Social Security tax they paid. One must pay Social Security taxes for a minimum of 40 quarters, or 10 years, to be eligible for benefits, which are figured on the basis of one’s Primary Insurance Amount (PIA) — the average of a worker’s 35 highest years of earnings (up to a particular year’s wage base), adjusted for inflation.

For those born in 1960 or later, the retirement age to receive full benefits is 67. Reduced benefits are available for those who have reached the age of 62. According to the Social Security Administration (SSA),

In the case of early retirement, a benefit is reduced 5/9 of one percent for each month before normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced 5/12 of one percent per month.

For example, if the number of reduction months is 60 (the maximum number for retirement at 62 when normal retirement age is 67), then the benefit is reduced by 30 percent. This maximum reduction is calculated as 36 months times 5/9 of 1 percent plus 24 months times 5/12 of 1 percent.

In plain English, if your retirement age is 67, then you will receive 70 percent of your benefit if you retire early at age 62, 75 percent at 63, 80 percent at 64, 86 ? percent at 65, and 93 ? percent at 66. My friend knew this. Most Americans realize this. As recently as 2005, 54 percent of women and 50 percent of men opted to sign up for Social Security at age 62. Now it is down to about 31 percent of women and 27 percent of men.

But what many Americans don’t realize is that half of their Social Security benefits might be withheld and a maximum of 85 percent of their benefits might be subject to taxation.

According to the SSA, “If you are under full retirement age for the entire year, we deduct $1 from your benefit payments for every $2 you earn above the annual limit. For 2021, that limit is $18,960.” And regarding the taxation of benefits,

  • Up to 50% of Social Security benefits are taxed on income from $25,000 to $34,000 for individuals or $32,000 to $44,000 for married couples filing jointly.
  • Up to 85% of benefits are taxable if the income level is over $34,000 for individuals or $44,000 for couples.

(Income is defined as adjusted gross income + nontaxable interest + half of Social Security benefits.)

For those who retire at their full retirement age, there is no limit on how much they can make. Nothing is deducted from Social Security benefits. However, their benefits are still subject to the same rates of taxation.

And then on top of that, thirteen states — Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, West Virginia) — tax Social Security benefits.

Everyone understands that there are reduced benefits for early retirement. If you want the full benefit, then you have to wait until your full retirement age. But what my friend, and no doubt many other Americans, didn’t realize is that the government would also withhold half of his benefits and tax the rest up to 85 percent. Many other Americans do realize this since, according to the SSA, “More than 40 percent of current beneficiaries pay income taxes on part of their benefits.”

Yet the vast majority of Americans still believe that retirees are entitled to Social Security benefits because they paid into the system their entire working lives.

But that couldn’t possibly be true. Not if the government can withhold half of your benefits and tax you up to 85 percent on the rest of them. If Americans are entitled to Social Security benefits because it is “their money,” then it shouldn’t matter how much money they make after retirement. Their income shouldn’t trigger the taxation of their Social Security benefits.

There is, in fact, no connection between Social Security taxes paid and Social Security benefits received. Benefits are calculated by an arbitrary formula that Congress can change at any time. Even worse, there is no contractual right to receive benefits. When Congress passed the Social Security Act of 1935 (H.R.7260), which was signed into law by Roosevelt on August 14, 1935, it put Social Security benefits in Title II and Social Security taxes in Title VIII with no reference in either title to the other.

So if Social Security is not a retirement plan, a trust fund, an annuity, an insurance program, a savings account, or a pension fund, then what is it? The true nature of Social Security is that it is an intergenerational, income-transfer, wealth-redistribution welfare program that takes money from those who work and gives it to those who don’t. And if that is the case, then Social Security — as much as food stamps, Section 8 housing vouchers, cash payments, and every other form of welfare — should be eliminated.

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