Let’s start with pensions.
If you are lucky enough to have a pension funded by your employer, the benefit to you is taxed as ordinary income. If you contributed to the pension, the portion you paid with after tax money is not taxable.
It is similar with Social Security. SS is funded using worker and employer payroll taxes, interest on trust held bonds and the income taxes paid on taxable SS benefits.
In other words, most of the Social Security benefits a retiree receives are not paid for/funded by the worker.
Look it up yourself. Go to your SS records and see every penny you and your employers paid in SS payroll taxes and compare that total to what you are collecting.
This means the taxation of SS benefits uses the same logic as taxing a private pension – you only pay income tax on income never taxed before, although SS is more generous than the IRC.
Federal Taxation of Social Security Benefits
• Up to 85% taxable: Unlike pensions, SS is never 100% taxable. Taxation depends on your “combined income” (AGI + nontaxable interest + ½ of SS benefits):
• Under $25k single / $32k joint: 0% taxable.
• $25k–$34k single / $32k–$44k joint: Up to 50% taxable.
• Above $34k / $44k: Up to 85% taxable.
• Why 50%/85%? These were pragmatic choices in 1983 and 1993 laws. The 50% roughly approximated the employer share of FICA taxes. The 85% reflected actuarial estimates that individuals “paid for” only ~15% of benefits via their own taxed employee contributions (the rest from employer shares, interest, and pay-as-you-go financing).
• Revenue use: Taxes on SS benefits help fund the SS and Medicare trust funds.
• Provisional income formula: Only a calculated portion (never the full benefit) enters your taxable income.
Only Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, and Vermont apply state income taxes to SS benefits and then several with income exceptions.
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