Social Security retirement benefits are a substantial source of income for many retirees. Payroll deductions fund Social Security and Medicare benefits. Suppose an employer pays you. In that case, you and the employer each pay 6.2 percent of your income, up to a maximum of $160,200 (in 2023—this amount is regularly updated). If you are self-employed, you must pay the employee and employer share, totaling 12.4 percent of income.
Medicare benefits are funded by a payroll tax as well. The employee and employer each pay 1.45 percent of their income, and there is no cap on the income subject to Medicare payroll taxes. In fact, employers must withhold an additional 0.9 percent on wages above $200,000. That additional levy is the taxpayer's responsibility, with no matching tax for the employer.
Your Social Security benefits are determined by how much you earn as a worker and the age at which you begin receiving benefits. Every recipient must have at least 40 "credits." A credit means that the individual worked for pay during a quarter. That means you can garner four credits every year that you work, or you can earn fewer credits if you work just a portion of a year. The 40 credits equate to ten full years of employment.
The higher your income is during your working life, the higher your benefits will be in retirement. It's also essential to note that the age at which you retire has a significant impact on the amount of retirement benefits. Anyone with at least 40 credits can retire at age 62. However, the benefits that you will receive at that age will be approximately 30 percent lower than the benefit would be if you wait until you reach full retirement age. For most people, the full retirement age is 67. However, if you continue working (or defer your benefits) until age 70, your benefit amount will be even higher.
No age milestone is associated with eliminating the taxability of Social Security benefits. The confusion in this regard likely stems from the age thresholds that affect the reduction in benefits for recipients still earning income.
However, if your only retirement income is your benefits, you will not owe federal income taxes. According to the Social Security Administration, about 40 percent of recipients do pay some taxes on their benefits. To determine whether your benefits will be taxed, you first need to calculate your “combined income.” This amount is your AGI (adjusted gross income) which includes any salary or wages, capital gains, business income, investment earnings, dividends, alimony, and non-qualified retirement account distributions, plus any interest income. The other component is half of the amount of your annual benefit.
For example, suppose a married couple filing jointly has $50,000 in combined benefits, capital gains of $30,000, interest income of $5,000, and earnings of $10,000. The combined income is $70,000 (half of the benefit amount plus the other elements. At this level (combined income above $44,000), the couple will owe federal taxes on 85 percent of the total benefits received.
It’s helpful to note that currently, only eleven states tax Social Security benefits. Each of those states has specific rules regarding the imposition of state income taxes.