Q & A
How does the government justify paying high benefits to high earners who didn’t pay taxes?
Complete Question: From what I understand, our Social Security benefits are determined based on our highest 35 years of earnings. However, there is a maximum amount of income that is subject to Social Security tax. That really doesn’t seem fair. No wonder the trust fund is going broke. If people with high earnings are getting a benefit based on those high earnings but didn’t pay taxes on all of those earnings, of course it’s going to hurt the trust fund. How does the government justify this?
Answer: What you are referring to is called the “Tax Max” and has been a hot topic in the news and for politicians recently. There are a lot of different opinions out there about whether or not increasing the tax max, or even eliminating altogether, will help the sustainability of the trust fund. What is really important, though, is understanding exactly how the tax max works.
First, you are correct that benefits are based on your highest 35 years of earnings. However, there is a common misconception regarding what happens with the income beyond the threshold that is not taxed.
For example, in 2015 the tax max is $118,500. Therefore, if John Doe makes $200,000, he will pay the Social Security tax of 6.2% on $118,500, not $200,000. Now let’s say 2015 is one of the highest 35 years of John’s earnings. When he files for Social Security, they will calculate his benefit using an income of $118,500 in 2015, NOT $200,000. Therefore, nobody is receiving a Social Security benefit on those earnings that they were not taxed on because of the tax max.