The Average American Pays This Much in Social Security Payroll Tax

By Sean Williams Markets Fool.com

For tens of millions of Americans, Social Security is an irreplaceable lifeline that ensures they can meet their monthly expenses.

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According to data from the Social Security Administration (SSA), 61% of current beneficiaries count on their Social Security benefits for at least half of their monthly income. This figure is even higher for unmarried elderly individuals (71%). Suffice it to say that without Social Security income, the poverty rate for retirees would be a lot higher.

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Social Security's shortfall inches closer

Yet America's most vital program for seniors isn't on the most solid financial footing. According to the Social Security Board of Trustees' report from last year, Social Security's Old-Age, Survivors, and Disability Insurance (OASDI) Trust is expected to burn through its reserves of more than $2.8 trillion by 2034. This dwindling of Social Security's cash cushion down toward zero is what has led a lot of working Americans to believe that the benefit won't be around for them by the time they retire.

Now, despite this worrisome forecast, there is a bit of good news: Social Security isn't going anywhere anytime soon. While benefits for current and future retirees could be adjusted downward to keep the program solvent, payroll taxes ensure that Social Security will be there for future generations. As long as people keep working, Social Security will keep receiving fresh revenue that it can pay out to its eligible beneficiaries.

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The importance of payroll (FICA) taxes

SSA data shows that payroll taxes comprised 86.4% of the $920.2 billion in revenue for the program in 2015, with interest income (10.1%) and the taxation of Social Security benefits (3.4%) making up the remainder. You'll note these figures don't add to 100% due to rounding. Assuming the Trustees report is spot on and the OASDI burns through its reserves by 2034, then interest income will no longer be a contributor, and practically every cent of revenue will be generated from payroll taxes.

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Payroll taxes, which are officially known as FICA taxes, are paid by working Americans on their wages and earned income with the purpose of adding revenue to Social Security and Medicare Part A. FICA taxes total 15.3% for most working Americans, though a majority of them pay just half of that directly. Employers and employees typically split the FICA taxes right down the middle (7.65% each). The self-employed are required to cover the full 15.3%.

When broken down a bit further, 6.2% of the 7.65% coming out of your paycheck goes to the OASDI (as is a matching amount paid by your employer), while the remaining 1.45% goes to Medicare Part A (with, once again, an equal amount being added your employer).

The 1.45% payroll tax on Medicare has no upper income boundary, meaning it's collected on all earned income from $0.01 until your last earned dollar, regardless of how high that amount is.

For OASDI, the 6.2% is collected on earned income up to $127,200 (as of 2017). Any income you earn above that is exempt from the Social Security payroll tax. This top-end figure is linked to the National Average Wage Index and adjusted annually. The one exception is if there's no cost-of-living adjustment, in which case the maximum taxable earnings figure stays the same the following year.

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Here's how much the average American pays in Social Security payroll taxes

That 6.2% of your paycheck that goes to Social Security can be broken down even further. Specifically, as noted by the SSA, 5.015% is paid to the Old-Age, Survivors Insurance Trust (OASI), with the remaining 1.185% being directed to the Disability Insurance Trust (DI).

Based on 2016 data provided by the SSA (when the maximum taxable earnings figure was $118,500), the average American wound up paying $2,463 into the OASI, and $582 into DI. Combined, we're talking about $3,045 paid into Social Security via payroll taxes each year for the average American. Another $712 was paid, on average, into the Hospital Insurance Trust for Medicare Part A.

In terms of maximum payroll taxes in 2016, no worker will have paid more than $5,943 into the OASI and $1,404 into the DI, for a grand total of $7,347. For the self-employed this maximum doubled to $14,694. Once again, there is no limit on how much a worker could pay into the Hospital Insurance Trust for Medicare Part A.

Payroll taxes could be the key to fixing Social Security

Increasing what Americans pay in FICA taxes is among the more than one dozen ways that lawmakers in Washington have suggested for keeping the Social Security Trust Funds from running dry. Democrats on Capitol Hill view it as one of the simplest solutions.

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A number of lawmakers, including former presidential candidates Hillary Clinton and Bernie Sanders (I-Vt.), have suggested increasing the payroll tax cap. Clinton suggested creating a tax moratorium on wages between $127,200 and $250,000, then re-applying the Social Security payroll tax on any income above $250,000. Other lawmakers say that eliminating the cap altogether is the smartest solution. Doing so would mean that the rich would pay considerably more in Social Security taxes without a commensurate increase in their eventual payouts. It would, however, cover a good portion of Social Security's long-term budgetary shortfall.

Another possible solution would be an across-the-board increase in payroll taxes. The Trustees report estimated an actuarial deficit of 2.66% of taxable U.S. payroll for the OASDI in 2016. In plainer terms, that means a 2.66% increase in the payroll tax would cover Social Security's budget shortfall. This would require increasing workers' responsibility from 6.2% of their earned income up to $127,200 to 7.53% (1.33% extra, or half of 2.66%, since employers would cover the remainder). This idea hasn't proven too popular: A survey by the nonpartisan Voice of the People found just 19% support for a 1% individual payroll tax increase to 7.2%. One can only presume that an increase to 7.53% would have even less support.

It's likely that any long-term fix for Social Security will need both political parties in Washington to work together. This means it would probably include both additional revenue via payroll tax hikes, and a reduction in benefits for future retirees via an increase in the full retirement age. Only time will tell if Washington can make progress on a problem that's getting closer by the day.

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