Q. For a retired taxpayer who has other income, a significant part of their Social Security is received and is then taken back to the federal government as income taxes. If I had a choice, I’d rather see the money go back into the Social Security Trust Fund than into general income tax revenues. If this were the case, it would keep the Trust Fund solvent for many additional years.
Are there any numbers available for how much income tax is paid on Social Security payments each year? —J.B., by email
A. While all tax revenue goes to the Treasury general account, the money received from the taxation of Social Security benefits is included as income in the annual reports done by the Social Security trustees. The tax revenue received is small relative to the total costs of Social Security. And it will remain small in the future— even as the percentage of retirees who pay taxes on Social Security income increases every year, due to the lack of indexing in the tax formula. The contribution from benefit taxation never accounts for more than a small percentage of the total costs of Social Security.
In Table IV.A3 of the 2016 report, for instance, the taxation of benefits brought in $31.6 billion of the $920.2 billion in revenue credited for the operation of Social Security. The Trustees’ intermediate estimate of revenue from the taxation of benefits in 2025 is $77.8 billion while total income is estimated to rise to $1,473.3 billion. So the taxation of benefits rises from 3.4 percent of revenue to 5.3 percent of revenue over ten years.
The impact of the tax on the growing number of middle-income retirees who will be paying it is much larger. As I’ve shown in other columns, many will see their federal income tax bill double. We can thank both political parties for this. Efforts to repeal the tax have fallen on deaf ears in Congress. Also, no effort to index the taxation formula for inflation has gotten traction, a great example of taxation without representation.
The tax, passed as part of the 1983 reforms that were supposed to make Social Security solvent for 75 years, may bother you and me, but it will have a much greater impact on our children and grandchildren.
Q. At some time—maybe the 1980s or 1990s–you used to make some comparison of portfolio returns that included a portfolio with a good portion of cash (maybe Treasury bills). As I recall, your comparisons concluded that the portfolio with a larger cash position still performed fairly well with much less volatility.
I have not seen any analyses of yours that made similar comparison for any “recent” time periods. Have I missed them? Could you include some analysis like that? I am inclined to keep some part of my portfolio in cash for use in buying when the market is down as well as a form of protection, but I don’t know what would be a good percentage for that cash portion. I am 69 and retired. —E.H., by email
A. You haven’t missed them; I haven’t done them. But the notion still works and is particularly relevant today. With today’s pathetically low yields, investing for yield is mostly risk with little reward.
Here’s an example. Suppose you are a basic Couch Potato investor and you’ve chosen to avoid credit risk. You might own equal amounts of the iShares 7-10 year Treasury Bond ETF (ticker: IEF) and the Vanguard Total Stock Market ETF. While the bond investment is less volatile than stocks, it’s still fairly volatile.
The 10-year standard deviation (a measure of price volatility) of the bond fund, according to the Morningstar website, is 5.06 percent while the standard deviation for the stock market fund is 15.75 percent. The overall portfolio standard deviation, a weighted average of the two, is 10.40 percent.
So, how much more can you invest in the stock market if you hold cash instead of the bond fund? Answer: Since cash doesn’t have price volatility, you can increase the stock portion of the portfolio from 50 percent to 66 percent. Basically, you’ve eliminated the risk in the bond fund and “used” it to create a portfolio with more stocks— but the same amount of risk— as the old stock/bond portfolio.
Note: you haven’t made risk disappear. You’ve just moved it from bonds to stocks.
Originally posted at https://assetbuilder.com/knowledge-center/articles/a-little-revenue-for-social-security-but-a-big-tax-for-many-retirees