The Amazing 115% tax rate!

 

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The taxation of Social Security benefits is confusing, complex, and inequitable.  Since 1993, many retirees have effectively paid a double tax on their retirement income.  In addition, those same retirees may be penalized for working.  They can lose $1 of benefits for every $2 dollars of wages earned.  When these factors are combined with state, local and payroll taxes, the combined, effective marginal tax rate can be quite amazing. 

 

The impact of these policies is illustrated in the following excerpts from How Social Security Picks Your Pocket (by Joe Fried, ©Algora Publishing, 2003):

 

And now, the amazing 115% tax rate!

 

This is a quiz.  Be alert.  Let’s pretend you have a good friend in Ohio who is single and age 63, and who has the following amounts of income:  wages – $11,000, interest – $500, private pension – $17,500, and Social Security – $16,000.

 

Your friend needs advice.  She wants to help her daughter with college expenses, and has travel plans, but she is a bit short on money.  She has a chance to earn $5,000 more by increasing her hours at work. Should she work the extra hours to earn more money?

 

Before you answer, consider the following breakout of her taxes, statutory and de facto, on the extra $5,000 she wants to earn:  

  Taxes to pay on extra $5,000 of wages (2001 tax rates)    

Type of Tax (statutory and de facto)

Amount

%
Loss of SS benefits due to earnings penalty $2,500 50.0
Extra federal income tax 2,543 50.9
Ohio income tax 223 4.5
Municipality tax 100 2.0
Social Security tax 310 6.2
Medicare tax 73 1.4

GRAND TOTAL

 $5,749 115.0

 

If your friend works those extra hours, she will pay $5,749 in taxes on the $5,000 she earns.  I hope she is not planning on a trip to Maui.                                                           

So now, please write your answer below.  Should your friend try to earn the extra $5,000, even though she will have to pay $5,749 in taxes on it?

Answer:  yes____   no____ 

The answer is “yes,” of course.  You see, despite the apparent tax problem, your friend will have no money problems whatever.   Senator what’s-his-name, from New England, is proposing a new federal program that will provide counseling to people who are having difficulties in managing their money.  Your friend will be just fine.

 

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Date last modified March 2010