Decoding Social Security Taxes

Have you ever wondered what this mysterious “Social Security” tax is, why we have to pay it, and why it has so many different names?
 

It all started with President Roosevelt, who signed the Social Security Act into existence back in 1935. So what’s happened in the 75+ years since then? Here’s everything you need to know.
 

What’s in a Name?


 

Let’s start with the names. The most common name is Social Security, a broad term that refers to a number of different taxes. For example, you may have seen the initials OASDI on your most recent paystub. This acronym represents Old Age, Survivors, and Disability Insurance, and it falls under the Social Security umbrella.
 

You have likely also heard of FICA, or the Federal Insurance Contributions Act. In short, FICA is how Social Security and Medicare are funded. On every payday, a set of deductions—6.2% for Social Security and 1.45% for Medicare—are collected from your pay, which are then matched by your employer and sent to a government trust fund. For Social Security, those funds are used for qualified retirees, those with disabilities, and survivors of deceased workers. The remainder is used to fund hospital insurance taxes, also known as Medicare taxes.
 

How Social Security Works


 

While it may seem like taxes never stop, the amount you’re taxed on Social Security actually has an annual cutoff or “wage base.” As of this writing, the wage base for Social Security is $127,200. That means that when you have been paid that amount in taxable wages, you and your employer will stop paying into the program for the rest of the year.
 

So how do you eventually get your share when you need it? As you pay into Social Security, you amass credits along with your working history. That’s right, your entire working history—even that summer job stocking shelves in your teenage years counted toward Social Security. Every job and contribution from the past, present, and future will continue to build up your Social Security share and monthly allotment when it comes time to hang up the gloves.
 

Cashing Out
 

 

Note that if you inherited your wealth or made your living without paying into Social Security, those funds will not be available to you. Simply put, if you have not paid in, you cannot cash out.
 

When you decide to retire, your monthly Social Security benefit will be based on the amount you paid-in and your retirement age. For example, someone who works until the ripe old age of 70 will commonly get a higher monthly payment than someone who retires at 62. You can see this anticipated monthly payment on your annual statement of individual estimated retirement benefits.

President Roosevelt felt so strongly about Americans’ rights to these funds that he ensured they could only be used for Social Security purposes. That means your payments are not being used to fund other government initiatives or programs. This, coupled with the fact the ratio of time spent working and retired has remained steady at 3:1, has allowed the Social Security program to endure for over 75 years.
 

There you have it, everything you need to know about Social Security taxes. There’s been some debate about the longterm future of the program—so be sure to keep that 401K healthy, too!