The recently released 2005 Social Security Trustees Report, a 225 page document that will never be confused with the eagerly awaited "Harry Potter and the Half Blood Prince," contains a table you can use to foretell an important part of your future.

Modestly titled "Table VI.F10. ---Estimated Annual Scheduled Benefit Amounts for Retired Workers with Various Pre-Retirement Earnings Patterns Based on Intermediate Assumptions, Calendar Years 2005-80", it estimates the future benefits of workers at four levels of income based on Trustee projections of future inflation and wage growth.

It all starts with the bedrock reality of 2005.

An average-wage worker retiring at age 65 this year, for instance, will receive benefits of \$14,833 a year. This will replace 42.2 percent of his \$35,149 in pre-retirement earnings. If two such workers are married and retire at the same time their total Social Security income will be \$29,666. Using the convoluted formula for the taxation of Social Security benefits, we learn they can have additional income from pensions, dividends, interest, or work that totals only \$17,167 before our friends in Washington will start to add some of their Social Security benefits to their taxable income.

Anything over that \$17,167--- only 66.6 percent of their income while working --- will cause a portion of their Social Security benefits to be included in taxable income.   Like the hated Alternative Minimum Tax, this tax reaches more people every year.

Why?

Like the AMT, the Social Security benefits tax isn't indexed for inflation. As dollar income (not to be confused with purchasing power) rises, it overflows the fixed \$32,000 limit for joint returns or the \$25,000 limit for singles.

So let's use the Social Security Trustee's Crystal Ball. Let's see what the future looks like to average workers who are 40 and 30 years old today. Let's see what their retirement benefits will be if they retire at age 65.

The table tells us a 40-year-old worker will retire with \$17,056 in 2005 dollars in 2030. This will replace 36.3 percent of pre-retirement income. A separate table that estimates inflation tells us it will take \$1.98 to buy what \$1.00 buys today. So that benefit check will be an impressive \$33,737 in nominal dollars. Two married workers would have Social Security benefits of \$67,474.

That's quite a sum even though it replaces less of their pre-retirement income than the \$29,666 collected by the same couple retiring this year. Unfortunately, the story doesn't end there.

Since half of their Social Security benefits is \$33,737, their Social Security benefits, alone, will exceed the fixed \$32,000 threshold for the taxation of Social Security benefits. As a consequence, \$1,737 of their Social Security benefits is subject to taxation. Basically, today's 40-year old workers will be subject to taxation of Social Security benefits when their retirement income exceeds only 35.4 percent of their pre-retirement income.

The retirees of 2005 won't experience that taxation until they hit 66.6 percent of pre retirement income. Viewed another way, every dime of other income will cause today's 40 year olds Social Security benefits to become taxable. The retirees of 2005, on the other hand, will have a \$17,056 tax-free running start.

"Subject to taxation" does not necessarily mean today's 40 year olds benefits will be taxed. Workers who have nothing but Social Security income won't be taxed because the standard deduction, elderly deduction, and personal exemptions will then total \$34,400 instead of the \$17,400 they total this year. This will wipe out any tax liability.

For today's 30-year old workers the future would be silly if the taxes weren't so ominous. The table from the Trustee's report tells us that a 30-year-old worker will retire with \$18,985 in 2005 dollars in 2040. This will replace 36.3 percent of pre-retirement purchasing power. Another table tells us it will take \$2.61 to buy what \$1.00 buys today.

So their benefit check will be a whopping \$50,635 in nominal dollars. This will give a two-earner retiree couple Social Security income of \$101,270.

Impressed?

Don't be.   Remember, it will then cost \$9.92 for a McDonald's lunch that now costs \$3.80. The inflated dollars will cause \$69,270 of their benefits to be subject to taxation. Adjusting their personal exemptions, standard deduction, and elderly deduction for inflation, the \$17,400 of deductions available today would have grown to \$45,363 by 2040, leaving \$9,316 of taxable income.

This will happen without a dime of income from other sources! In other words, a hard working couple will pay income taxes on their Social Security benefits alone, even though those benefits replace only 36.3 percent of their pre-retirement income.

Confused?

Don't feel bad, you could run for Congress. Many of legislators who voted this atrocity into law in the nineteen eighties are still in office.

Next Tuesday:   Another slice of the same issue--- what will happen to today's 30 and 40 year olds when they add other income to their Social Security benefits.

More!

Sunday, April 10, 2005, "TITLE" Get URL

The 2005 Social Security Trustees Report

Table VI.F10 from the 2005 Social Security Trustees Report (Estimated Annual Benefit Amounts)

Tuesday, February 11, 2003, "Torpedo Tax can cause a sinking feeling"

Tuesday, February 18, 2003, "Don't get caught in early retirement tax trap"