As the name indicates, Social Security is the federal government's social welfare program that provides some level of financial and health care support during the retirement and during disability. It is primarily used to supplement your post-retirement income coming from pensions and retirement savings. In case of death or disability of a working person, his/her dependents also get financial help.
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The way this program works is that today's working Americans fund the Social Security with the Social Security taxes they pay. These taxes are also called Federal Insurance Contribution Act or simply FICA. A significant portion of these collected funds is then disbursed to those drawing benefits currently and the rest is put in high quality investments. A vast majority of the Social Security benefits are paid in the form of retirement and survivor benefits (about 70%). About 20% is used for Medicare, 10% for disability benefits and about 1% is the administrative cost. The Social Security benefits also have a cost of living adjustment (COLA) for the benefit payouts. This means your benefits increase with the inflation. The Social Security benefits are taxable for those in higher income groups. There are concerns that if the current demographic trend and Social Security tax level continue, Social Security may run out of funds by around year 2040. According to some studies, about 20 years back one retired person was supported by 4 working persons on an average. But currently it is down to 3 persons and is expected to come down to just 2 due to the longevity. Given this situation, it may not be appropriate to overly rely on Social Security system.
The Social Security Administration collects a portion of your paycheck in the form of FICA taxes before you get paid. Both the employer and the employee pay a fixed 6.2% each of the employee's gross pay up to $160,200. Self-employed people pay 12.4%. In addition, there is a fixed 1.45% of the gross that Social Security Administration (SSA) collects for Medicare from the employer as well as the employee. This is a flat tax and unlike Social Security tax, it has no income limit.
There are 6 major categories of benefits administered by Social Security. Benefits are typically computed using "average indexed monthly earnings." This average summarizes up to 35 years of a worker's earnings. A formula (to reflect changes in general wage levels, as measured by the national average wage index.) is then applied to this average indexed monthly earnings to determine a person's Primary Insurance Amount (PIA).
