Question

A major concern with Social Security is the possibility that funds will not be available when today’s tax-payers retire to become beneficiaries. According to the Social Security Trustee’s report, an increase of 1.89% in the Social Security payroll tax would keep the account full for the next 75 years. To achieve similar results, benefits would have to be decreased from the current 42% of the ending salary to 29% of the salary.
Cindy is relatively new to the workforce. She has 32 years until she can retire. Her current annual salary is $45,000.

1a) Calculate how much Cindy will have to pay in Social Security tax (6.2%) based on this salary.
1b) Calculate how much Cindy will have to pay in Social Security tax if the tax was increased by 1.89%.

2a) Calculate Cindy’s annual Social Security benefit (about 42%) if her salary remains unchanged until she retires (annual average is $45,000).
2b) Calculate Cindy’s annual Social Security benefit if her salary remains unchanged but benefits (based on her annual salary of $45,000) were cut from 42% to 29%.

3) If Cindy were given a choice between the increase in Social Security tax now or the decrease in Social Security benefits when she retires, which would you recommend she choose? Explain your answer thoroughly.

Answer 1

Below are the calculations and a recommendation. I assume the 1.89% increase is additive (i.e., 6.20% + 1.89% = 8.09%); if you meant a relative increase (6.20% × 1.0189) the numbers would be very slightly different.

1a) Social Security tax now (6.2% of $45,000)
- Tax = 0.062 × 45,000 = $2,790 per year.

1b) Social Security tax if rate increases by 1.89 percentage points (8.09% of $45,000)
- Tax = 0.0809 × 45,000 = $3,640.50 per year.

2a) Annual benefit at 42% of salary
- Benefit = 0.42 × 45,000 = $18,900 per year.

2b) Annual benefit at 29% of salary
- Benefit = 0.29 × 45,000 = $13,050 per year.

3) Recommendation and reasoning
- Extra tax per year if the rate is increased: $3,640.50 − $2,790 = $850.50.
- Total extra paid over Cindy’s 32 working years until retirement: $850.50 × 32 = $27,216.
- Annual benefit loss if benefits are cut from 42% to 29%: $18,900 − $13,050 = $5,850 per year.
- Break-even: $27,216 ÷ $5,850 ≈ 4.66 years. That means after about 4.7 years of collecting full benefits in retirement, the extra taxes she paid would be more than recovered compared with taking the benefit cut.

Conclusion: I would recommend accepting the modest payroll-tax increase now rather than accepting a permanent benefit cut at retirement. The additional tax burden ($850.50/year) is small relative to the annual benefit reduction ($5,850/year) and is paid over many working years, and the break-even time in retirement is short (under 5 years). Other reasons to prefer the tax increase: it preserves predictable benefits, reduces longevity risk (you likely will live well beyond the 4.7-year breakeven), and spreads the cost across working years and across the workforce.

(Notes: a more detailed comparison could include discounting/future-value, expected length of retirement, employer share of payroll taxes, wage growth, and inflation, but the simple arithmetic above already strongly favors the tax increase for Cindy.)