Formally titled as Old Age, Survivors and Disability Insurance (OASDI) by the Social Security Administration, Social Security is a federal program that provides monthly income for qualified retirees and their spouses, monthly survivor benefits to the spouse and family of a deceased OASDI recipient, and financial protection to OASDI recipients who become disabled.
Social Security FICA Payroll Taxation
Also enacted in the same year, Congress passed the Federal Insurance Contributions Act (FICA) and created the FICA Payroll Tax in order to fund Social Security. This Act was later amended to include funding for Medicare Part A and Medicaid. FICA taxes accumulate in a trust fund created solely to finance these federal and state programs.
FICA taxes are imposed on an employee’s wages up to a maximum annual amount, known as the Social Security Wage Base. This income limit, or ‘wage base,’ is set by the Social Security Administration and allows for taxation on all income earned up the current year’s wage base, which the administration typically increases 2-3% annually to reflect rising inflation. Income amounts exceeding this taxable ceiling are not taxed under FICA for Social Security purposes.
In regards to Medicare funding, no such income limit exists, meaning that an employee’s entire annual wages are FICA taxable for Medicare purposes. In addition, FICA taxation is strictly a payroll tax and is not required for any earning or financial gains on investment performance, such as interest earnings or dividend returns.
Currently, the FICA tax rate remains at 6.2% and is scheduled to stay the same for the upcoming few years, although historically, it can and has changed over time. An additional Medicare tax of 1.45% is added to the FICA rate for a total of 7.65% per employer and employee. Combined, Social Security collects 15.3% in FICA Payroll taxes from employers and employees annually to support and fund Social Security’s various programs.
Self-Employment Contributions Act (SE Tax Act)
In 1954, Congress also enacted the Self-Employment Contributions Act (SE Tax Act) to impose a similar payroll tax for self-employed individuals. Under the SE Tax Act, self-employed individuals are viewed as both the employer and employee, and are taxed on (6.2 + 6.2) and (1.45% + 1.45%), or a 15.3% SE tax for Social Security and Medicare funding.
The SE tax is only imposed on 92.35% of net earnings versus 100% of gross income with a 7.65% difference that is exactly half of the 15.3% imposed. Essentially, this difference in the taxable wage amount for self-employed individuals provides more equality in taxation between employed and self-employed taxpayers.
Who is Covered by Social Security
Social Security is available to all working Americans that pay FICA taxes and become eligible for OASDI benefits upon certain qualifying events such as reaching the normal retirement age, survivorship benefits for a spouse and children of a qualified deceased Social Security recipient, or for Social Security disability benefits upon becoming disabled.
An individual becomes ‘eligible’ for Social Security benefits based on his or her Insured Status, which is determined by how many Quarters of Coverage or Credits he or she has accumulated while being employed and taxed under FICA.
One credit can be earned for each quarter in the calendar year that an employee pays FICA payroll taxes, with a maximum annual accumulation of 4 quarters of coverage, or credits, per calendar year, beginning after an individual turns 21 years old.
Insured Status (Currently vs. Fully)
Currently InsuredAn individual qualifies as partially insured, also referred to as Currently Insured, if he or she has accumulated at least 6 quarters of coverage within the last 13 calendar quarters. The minimum requirement for individuals under age 24 to obtain currently insured status is 6 credits in the last 3 years. Beginning at age 24, additional credits are required to obtain currently insured status based on the individual’s age at the time of disability.
Limited benefits are available if an individual is currently insured in comparison to full benefits when the individual is fully insured. If a worker is ‘currently’ insured at his or her time of death, benefits would continue to be payable to dependent children of the deceased recipient.
Fully Insured
An individual qualifies as Fully Insured when he or she has accumulated the required quarters of coverage based on their age.
To be fully insured, an individual needs to obtain at least one credit for each calendar year after turning age 21, and the earliest of the following:
The year before attaining age 62,
The year before death, or
The year an individual becomes disabled
The minimum number of credits needed is 6 and the maximum number needed is 40. Any year (all or part of a year) that was included in a period of disability is not included in determining the number of credits needed to be fully insured.
Fully and Permanently Insured
To be considered Fully and Permanently Insured requires an individual to work approximately 10 years to obtain the maximum of 40 credits.
Once an individual has earned 40 quarters of coverage, he or she is fully insured and permanently eligible for Social Security retirement benefits once he or she retires, disability benefits if he or she becomes disabled, and premium-free Medicare Part A benefits, regardless of whether or not he or she continues to work in the future.
Normal Retirement Age (NRA)
The Normal Retirement Age (NRA), also known as the Full Retirement age, is considered to be the age that an individual becomes fully eligible for Social Security benefits. An individual’s qualifying age is based on when he or she was born. The average age of current Social Security beneficiaries ranges between age 65, for individuals born before 1937, to age 67 for individuals born in 1960 and later.
Although the normal retirement age is between ages 65-67, a covered Social Security recipient can start receiving benefits as early as age 62; however, benefits are reduced by a fraction of a percent for each month before the normal retirement age of the covered individual.
Social Security pays the same amount of benefits for each recipient over his or her lifetime, whether or not the individual elect to receive early benefits, or delays benefits to a later date. Benefits are reduced for early enrollment to account for a longer benefit period; likewise, if an individual chooses to delay Social Security benefits to a point in time after his or her normal retirement age, benefits would be increased to account for a shorter benefit period.
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