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Uncap Social Security carefully

By Jennie L. Phipps · Bankrate.com
Thursday, June 20, 2013
Posted: 5 pm ET

A retirement planning blog I wrote three weeks ago on raising Social Security's minimum age to collect benefits from 62 to 63 or 64 has generated nearly 700 comments.

Dozens of people have said raising the wage cap is the simplest and most expedient way to make Social Security solvent. But this solution isn't as neat as it seems.

Currently, the cap on wages subject to tax is $113,700. Social Security's retirement benefits are calculated so that lower-earning workers get back 90 percent of the first $767 of their average indexed monthly earnings over 35 years. They get 32 percent of the next $3,857 in earnings. Higher earners also get 15 cents on the dollar for every additional dollar they earn over $4,624, up to the current earnings cap.

The only way to solve the Social Security shortfall by raising the earnings cap is to also cap benefits so that high earners get no return on the Social Security taxes that they would pay above the current cap.

The government is already collecting higher Medicare taxes on higher earners and giving them no return on the extra money they pay. Beginning this year, there is a new 3.8 percent Medicare surtax on the lesser of net investment income or the excess of modified adjusted gross income, or MAGI, above $200,000 for individuals or $250,000 for couples filing jointly. Earners whose MAGI is above $200,000 also pay an additional 0.9 percent in payroll taxes on the amount above that threshold and their employers have to match it.

Reader Bill Mack posted this calculation in response to the discussion of eliminating the earnings cap:

"If you remove the income cap on Social Security, the top income tax rate for people in high tax states like California rises to 61.5 percent (39.6 percent  federal income taxes, 13.3 percent state income taxes, 6.2 percent Social Security payroll taxes, 1.45 percent and 0.9 percent Medicare and Obamacare surtaxes).

"Do the proponents of this idea really think this is a reasonable tax rate?"

Remember that this tax wouldn't just hit the highly compensated Big Guy. It also would be levied against average workers who take a buyout, get severance, sell a business or otherwise receive a lump sum that can't be rolled into an IRA or other tax-advantaged plan. For a year, it would push them into a much higher tax bracket, and in that year what might have seemed like a generous retirement nest egg would be more than halved by taxes.

At the very least, if we choose this route to stabilizing Social Security, we should step carefully.

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2 Comments
SteveD
June 23, 2013 at 6:12 am

@ William Stover. Dollars do not exist in any physical sense. They are an accounting fiction, wholly controlled by our Monetarily Sovereign government, which can create an infinite number of them, simply by crediting accounts. The government can credit Medicare, Medicaid and Social Security accounts endlessly, just as it can credit all federal agency accounts, endlessly. Constraint? INFLATION!!! (which can be controlled via interest rate adjustments by the FRB).

William Stover
June 21, 2013 at 9:01 am

If the government had only used SS funds for SS and would only
use the same in the future, I believe that would solve the problem!