Social Security FICA: Tax, Pension, or Disability Insurance Policy?

Well, as fun as it is to blog about skiing the east and buying lambs, it is time to get back to business. I promise you, all these tax articles are going to come in handy once we start talking about saving money on healthcare.

Here at Max Out of Pocket, we always expect the best, but plan for the worst.

I just couldn’t help myself. Max OOP’s slightly ridiculous Social Security Card.

We learned a few weeks back that most Max OOP readers likely pay $1.45 of every $100 in earned income into Medicare. This tax is collected through FICA payroll taxes to help cover the Medicare program’s Part A hospital benefits for when you get old and grey. In total, it comes out to about 1.45% of earned income and there is no wage base limit on how much they can tax. We now need to cover the other piece of FICA – Social Security.

Social Security: How Much Do I Owe?

For most of us, in 2019 we will pay $6.20 on every $100 we earn to the Social Security Administration as mandated by the Federal Insurance Contributions Act (FICA) in 1935. This comes out to 6.2% of earned income and is taken directly out of our paycheck. Like with Medicare, your employer pays a matching 6.2% of your wages to Social Security as well. If you are self-employed, sorry, you are on the hook for the whole 12.4%.

With the exception of a few years during the great recession, Social Security FICA payroll taxes have been pretty stable since the 1990’s. We don’t see a lot of fluctuation with the percentages so the tax is basically baked into the economy at this point.

Here is a nice link from the IRS corroborating these numbers for when you do your own research on the subject.

FICA Cheat Sheet

This pie chart of course ignores other premiums and taxes including Medicare FICA, etc. The goal of this sophisticated chart is to help visualize how much of your cash is going to the Social Security Program.

Good News For High Income Earners

We learned with the Medicare portion of FICA there was no income threshold where the Medicare tax phases out. In fact, with Medicare FICA, they actually increase the tax for higher wage earners. The Social Security portion of the tax actually has a maximum income level where they stop taxing you. In 2019, that maximum is $132,900. So the most Social Security you would have to pay through payroll regardless of income is $8,239.80.

$132,900 X 6.2% = $8,239.80

This is for each employee, so multiply this by two for married couples.

Good News For The Early Retired

As with Medicare, you might have noticed I kept repeating “earned income” above.

The FICA/Social Security Tax is applied only to earned income. So, like with Medicare, if you retire early and sail off into the sunset living off your investment portfolio, this tax essentially goes away. Keep in mind though, your actual Social Security benefit payment when you hit your golden years would likely be reduced in the event of an early retirement. This is because the calculation is based on income averages from your working years. Throwing a few $0.00 years in there will hurt your average. We will cover more on that at a future date. Also, the Net Investment Income Tax we mentioned in the Medicare series does not apply to Social Security.  

Social Security: Tax, Pension, or Disability Insurance?

Max OOP considers Social Security not only a pension, but also an insurance policy that would kick on in the event of disability.  

Once again, regardless of your tax philosophy, knowing how much you pay into this program is important for when our political leaders start tinkering with these numbers. As much as it is talked about in the news, the US social security retirement benefit likely won’t just run out and go away one day. I am not saying the tax structure or payment model won’t change, but some cash will be there for Max OOP when I finally hit that golden age. Max OOP doesn’t include Social Security income in my early retirement calculations, but I am 99.9% certain something will be there.

It will also be there if I need it in the event of an unexpected accident causing disability. My social security statements says I would get $2,251 a month if I become disabled “right now”. I just thought of about 3 ways I could become disabled “right now”. One was an electrical keyboard malfunction/situation disabling all ten fingers and thus flushing my cubical rockstardom down the drain. If I was determined disabled by this scenario, the annual disability payment would come out to about $27,012 per year.

Per the Social Security website. That link in the image doesn’t work, so don’t wear out your mouse trying to steal Max OOP’s disability benefits.

To put up this kind of security and protection against disability, Max OOP would need a ‘disability investment portfolio’ of about $900,000. This assumes a safe withdrawal rate of 3%. I choose an overly conservative 3% withdrawal rate as opposed to the 4% rule of thumb because odds are I wouldn’t be as flexible to cut expenses or generate additional income if I was in a disabled state (particularly if all 10 fingers were inactive). If you ask Max OOP, $27,000 annually is a pretty solid insurance policy and takes some of the weight off my shoulders when planning for the worst.  

$900,000 X 3% withdrawal rate = $27,000

Since everyone has a different disability benefit number, do you know how much you would get from social security if you became disabled “right now”?

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