If you want to replace your purchasing power in retirement, you'll have to pay more taxes to Uncle Sam today. You'll have to pay still more tomorrow. This will happen because Uncle Sam has had the power to tax Social Security benefits since 1983.

Few noticed back then because so few were taxed. One half of your Social Security benefits plus all your other income had to exceed $32,000 for couples, $25,000 for singles. Very few retirees exceeded the threshold because $32,000 went nearly twice as far in 1983 as it does today.

And that's the problem.

Every year retirement benefits rise but the $32,000 and $25,000 thresholds remain. As a consequence, more and more retirees are paying taxes on Social Security benefits. Last week I showed that an average couple retiring in 2005 could have additional income of $17,167 before any of their Social Security benefits were subject to taxation. Average income couples that are now 30 and 40 years old, however, can expect that any income they have beyond their Social Security benefits will cause their benefits to be taxable.

This is one of the generational inequities Professor Laurence J. Kotlikoff and I point out in "The Coming Generational Storm: What Every American Needs To Know About America's Economic Future" (MIT Press, 261 pages, paperback, $16.95).

But let's take a still closer look. According to the 2004 Georgia State University/AON retirement income study, a newly retired two earner middle-income couple today needs about 75 percent of their combined pre-retirement income in retirement. The 75 percent figure reflects adjustments made for employment taxes, lower income taxes, savings, and work related expenses.

How much more in taxes will today's 30 and 40 year olds pay if they try to do the same thing--- replace 75 percent of their earning power at retirement?

The short answer: a lot more.

Here's what I learned comparing the prospects of three couples trying to achieve the same goals at different times.
  • Today's average retiring couple can have other income of $17,167 before any Social Security benefits are subject to taxation. Only $5,980 of the $23,057 of additional income they need to replace 75 percent of their earning power will cause their benefits to be taxed. Only $2,945 of their benefits will be subject to taxation. As a consequence, the federal income tax will take only 1.6 percent of their $52,723 income and their top tax bracket will be 10 percent.
  • For a couple that is 40 today, there is no $17,167 running start. They will need $71,934 of income from other sources to replace 75 percent of their pre-retirement income of $185,877. As a consequence, virtually all of their benefits will be taxed, their top tax bracket will be 15 percent. More important, income taxes will take 9.1 percent of their $139,400 income (in inflated dollars), nearly 6 times the burden on today's retirees.
  • A couple that is 30 today will have maximum Social Security benefits subject to taxation---85 percent. They'll also need $105,532 of income from other sources to replace 75 percent of their pre retirement earning power . They will be in the 15 percent tax bracket. They will lose 9.7 percent of their income to income taxes, six times the burden on a 2005 retiree.
These figures are based on inflation and earnings assumptions made by the Trustees for Social Security plus the assumption that future income tax incomes, deductions, and exemptions will continue to be indexed for inflation. What we experience may be different. As things are today, however, tomorrow's retirees will have a significantly higher tax burden than those of today.

Amazingly, these figures don't represent the full impact of Social Security benefit taxation.   Future retirees will need to have more in savings to duplicate what current retirees do with much less. The couple that needs $23,057 of other income plus Social Security benefits to replace 75 percent of their earning power today will need an investment portfolio of about $546,000 to do it. Today's 30 year olds will need an investment portfolio of   $2.6 million to do the same thing. That's a 75 percent increase--- after adjusting for inflation.

All this has been in tax law since 1983. It's a sly inflation-based tax trap for the young. All efforts--- and there have been many--- to end this generational tax mugging have been defeated. This happens because politicians of both parties continue to buy the votes of today's seniors with the income of next generation.  

That, dear reader, is one of the reasons we need to chuck the entire tax code and start over.

Is there a less extreme (and more likely) alternative?   Yes. Write your representatives and tell them you support House Bill 424. If your representative won't vote for it, let them know you won't vote for them. Texas Congressman Ron Paul sponsors the bill.


H.R. 424--To amend the Internal Revenue Code of 1986 to repeal the inclusion in gross income of Social Security benefits. Corrected Editors Reference Table:

Comparing Three Retiree Couples
Current Couple Age




Year Couple will be 65




Scaled Medium Worker Benefit in constant dollars




Replacement rate




Inflation factor




Benefit in Nominal Dollars




2 Earner Couple SS Benefit




SS Subject to Taxation




Couples pretirement income




Total Income Required for 75% RR, not considering taxes




Income Required from Other Sources




Other Income that would engage SS taxation




Maximum SS benefits that can be taxable




Benefits remaining after $12,000 limit of 50% band




Other Income remaining after $12,000 limit of 50% band




Income required to make remaining benefits taxable




Total Benefits Taxable




Percent of Benefits Taxable




plus Other income




equals Adjusted Gross Income




less Standard and Elderly Deductions, 2 Pers Exemptions




equals Taxable Income




inflation adjusted Taxable income




Increase in inflation adjusted taxable income from now




Estimated Federal Income Tax (inflation adjusted)




Estimated Tax as % Total Income




Estimated loss of purchasing power from 2005 due to taxes




Estimated Marginal Tax Rate




Capital Required at 4% to produce other income




Capital Required Index to Produce Gross Income




Inflation Adjusted Capital Required