Social Security Tax: What It Is And Why It Matters To You

Social Security can be confusing, especially for those just starting out in the workforce. It’s vital that Americans understand the Social Security system, how it works and how they may be taxed now and in their retirement.

Let’s look at how Social Security tax impacts retirement savings and income.

What Is Social Security Tax?

In effect, there are two meanings to the term “Social Security tax.” One refers to money that has been deducted from their paycheck their entire lives. The other is a tax on the actual Social Security payments they receive in their retirement years.

The first definition of Social Security tax refers to money that is deducted from your paycheck. It is usually listed separately from your other payroll taxes as the FICA tax, which was born of the Federal Insurance Contributions Act (FICA) passed by Congress in 1935.

Applicable to earnings such as salaries, hourly wages, bonuses and tips, the FICA tax funds Social Security as well as Medicare, which is federal health insurance for anyone age 65 and older, and some people under 65 with certain disabilities or conditions.

Although its primary purpose is to provide a continuing source of income to retired workers and their families, the Social Security program also provides financial assistance to disabled workers, as well as the surviving spouses, children and dependent parents of deceased workers.

In 2023, FICA taxes add up to 7.65% of your paycheck in total. These monies are divided, with 6.2% tax going toward paying Social Security (applicable to wages up to $137,000) and 1.45% tax going toward Medicare (with an additional 0.90% applied to any wages above $200,000). Further, your employer must match your contribution at 100%, so effectively 15.3% of your earnings go to these two retirement programs (12.4% to Social Security, 2.9% to Medicare).

So what if you work for yourself and don’t receive a paycheck? Well, you must still make a full accounting of your earnings to the federal government. And in accordance with the Self-Employed Contributions Act (SECA), you must pay both the employee and employer halves of your FICA tax — the full 15.3% of your net income.

Is Social Security Taxable?

If you are currently collecting a monthly Social Security benefit, you may not have to pay tax on that income, or you may be taxed for a percentage of it. Those who must pay tax typically have additional sources of income, such as wages from a job, self-employment income or dividends from a retirement account that must be reported as income on their tax return.

How much of your Social Security is taxable will depend on your income and how you file your taxes – however, the highest percentage of your Social Security benefit that is taxable cannot exceed 85% under current IRS rules.

As of 2023, you likely will have to pay tax on Social Security income if you file your taxes in one of these below scenarios:

File a federal tax return as an "individual" and your combined income (meaning your Social Security benefit plus income from a job or retirement account) is:

• Between $25,000 and $34,000: you may have to pay income tax on up to 50% of your benefits.
• More than $34,000: up to 85% of your benefits may be taxable.

File a joint return, and you and your spouse have a combined income that is

• Between $32,000 and $44,000: you may have to pay income tax on up to 50% of your benefits.
• More than $44,000: up to 85% of your benefits may be taxable.

Are married and file a separate tax return, you probably will pay taxes on your benefits.

How Social Security Taxes Are Calculated

The Social Security and Medicare tax, or FICA, is just one type of income tax deducted from your paycheck. All U.S. states are slightly different and percentages of tax vary depending on income, but most people also pay a federal income tax, a state income tax (not applicable in several states), and (in some locales) a city or county tax.

The Social Security tax rate is handled through employee payroll. Employers and employees each pay 6.2% of the employee’s income toward Social Security benefits. If you are self-employed, the rate is 12.4%.

Because the FICA tax also covers Medicare, an additional 2.9% is deducted (1.45% from both employee and employer). This brings the total FICA tax to 15.3%.

How To Report Social Security Income

Tax returns can be complicated documents, with different types of income (such as wages, self-employment income, interest, dividends, etc.) seen differently by the Internal Revenue Service (IRS). Social Security is another form of income that becomes a part of your adjusted gross income when you prepare your tax return.

The amount of Social Security benefits you received for the previous tax year is reported in Box 5 of Form SSA-1099 that you’ll receive in January. You then report that amount on line 6a of Form 1040 (U.S. Individual Tax Return) or Form 1040-SR (U.S. Tax Return for Seniors).

State Taxes And Social Security

Most U.S. states do not tax your Social Security income. However, in 2023 the following 11 states do have a Social Security tax: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah and Vermont. All other states and the District of Columbia do not tax the payments.

Ways To Reduce Social Security Tax

How much federal tax you pay — if you pay any at all — on your Social Security income depends on your annual combined taxable income. This is your total income, from Social Security plus any wages, self-employment earnings, retirement accounts, etc. You’ll pay zero tax on your Social Security earnings if the total income is:

• Less than $25,000, if you’re filing as an individual
• Less than $32,000, if you’re married filing jointly

If your total income does exceed these numbers, between 50% and 85% of your Social Security earnings will be taxed.

There are a few ways to keep your combined retirement income down, but you should consult with a financial planner to see if any of these strategies are in your best interest.

• Delay taking your Social Security benefit: You can begin taking Social Security anytime between age 62 to 70. The longer you delay, the higher your monthly benefit. If you still want to work past 62 and can live comfortably without the Social Security check, it’s probably best to wait.
• Put money in your retirement accounts: The reason to have an IRA or 410(k) when you’re younger is because it takes your pretax earnings and invests them. Not only does that money hopefully grow, if you wait until retirement to pull it out you don’t get taxed on it. If you’re in your early to mid-60s, are still working and making plenty to sustain your current lifestyle, you can continue to fund your IRA and keep your combined income down.
• Don’t pull money out of your retirement accounts: Any income you do pull out of your 401(k) or retirement account before you reach a certain age is considered income and counts toward your adjusted gross income.
• Take a tax loss on investments: If you have an investment that has lost money in the current year, you can sell it and claim the loss as a tax deduction. Currently you can claim up to $3,000 in tax losses to reduce your income.

The Bottom Line

You’re never too young to begin thinking about and saving for retirement. Since your Social Security benefit will be an important source of income when you get there, it’s good to understand how the system works.

Americans begin receiving a Social Security statement in the mail annually at age 60. This document details how much your monthly benefit is expected to be at age 62 and how it progressively grows the longer you put off collecting. However, anyone over 25 can view their Social Security statement online by creating an account at https://www.ssa.gov/.

Another great way to keep track of your current budget, monitor and grow your investments and plan for retirement is by signing up for the Rocket Money^SM app—download the app today.