It can get terribly expensive for seniors — people in their 60s — to keep working instead of retiring, even if they do so because they fear running out of money when they do retire.
A new study from Alan J. Auerbach, Laurence J. Kotlikoff, Darryl Koehler and Manni Yu found that those working seniors can end up forking over their hard-earned money at a much higher rate than do millionaires and billionaires.
How is such a thing possible? There are actually penalties for working that stem from approximately 30 major federal and state tax and transfer programs. The project, funded by the Sloan Foundation, analyzed those penalties, as well as considering how the additional earnings, a part of which will generally be saved, will affect future taxes and transfers. The entire impact is summarized in what is called the worker's "lifetime marginal net tax rate."
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"Senior workers earning an average income can easily lose more than half of their earnings to higher taxes and reduced government benefits," Kotlikoff, who is an economist at Boston University, said in a statement. He added, "In some cases, workers can lose 95 cents out of each dollar they earn."
The top offender? The Social Security system, which beyond a certain income level, takes back 50 cents of Social Security benefits for each dollar earned by early retirees from age 62 to 66. That's a 50 percent tax rate. Then there's the 33 percent tax rate it extracts from working seniors from January 1st in the year in which they turn 66 until their 66th birthday — in the form of taking back 33 cents of benefits for each dollar of wages.
And that's after the bite taken out by income, payroll and other taxes. Even though the government does begin to add the benefit reduction back once the worker reaches the normal retirement age, many seniors don't realize that or don't understand it.
Then there's the Social Security benefits tax, which hits seniors up for income taxes on 50 cents of Social Security benefits for each dollar they earn once they pass a certain threshold. That boosts their marginal tax rate by 50 percent. If they earn even more, they'll end up paying income tax on 85 cents of Social Security benefits for every dollar they earn, increasing their marginal tax rate by 85 percent. When the Social Security benefits tax is added to the earnings penalty, the tax rate on moderate-income seniors can actually reach 95 percent.
And when you consider savings, the Social Security benefits tax penalizes that, too. Someone in the 15 percent bracket for ordinary income, for instance, can see the tax rate on pension income and IRA withdrawals rise from 15 percent to 27.75 percent, with the benefits tax. It can also raise the tax on capital gains and dividend income from zero to 12.75 percent, and make tax-exempt income taxable at a rate of 12.75 percent.
"These high marginal tax rates only hit in the middle of the income ladder. They don't affect the work incentives of the rich or the poor," Kotlikoff continued, adding, "However, the loss of the Earned Income Tax Credit and the potential loss of Medicaid and other entitlement benefits create high marginal tax rates for low-income workers in other ways."
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