Social Security is a massive redistribution scheme -- and why gamblers, hookers, illegal aliens, and other under-the-table workers should report some income

You may have heard that Social Security pays an awful return on the money you put in. That's true -- except for the poor. Very low-income workers get a massive return on the money they pay in.

Here's how it works:

For an individual who first becomes eligible for old-age insurance benefits or disability insurance benefits in 2016, [...] his/her [benefit] will be the sum of:
(a) 90 percent of the first $856 of his/her average indexed monthly earnings, plus
(b) 32 percent of his/her average indexed monthly earnings over $856 and through $5,157, plus
(c) 15 percent of his/her average indexed monthly earnings over $5,157.

See how that works? A huge return on the first $856 per month you report, much less on the next $4,301, and almost nothing on everything above that. So if you're paying the maximum Social Security tax on income of $118,500, you're getting almost no credit for almost half the money you're paying in.

Take for example someone who earns the $856 monthly for 35 years (ignoring indexing and inflation for the sake of simplicity; it doesn't change the principle). With a combined Social Security tax rate of 12.4%, he and his employer would have paid in $44,580 over his career. Now assume he retires at 66 and lives 15 years more. He'll get 90% of that $856 monthly, or $9245 per year, for a total of $138,672 over 15 years -- far more than he paid in!

Now take someone who earns the maximum taxable $118,500 for 45 years. He and his employer would have paid in $661,230. But his monthly benefit would be just $2854 (the actual maximum benefit is currently $2639 due to differences in wage inflation and cost of living). That would be $34,253 per year or $513,796 if he lived 15 years in retirement -- a negative return on the money he paid in.

Clearly, it pays to report that first $856 per month of income to get a big payback on Social Security.  Cash workers, stay-at-home spouses, middle-aged immigrants, and anyone else expecting to live into retirement age should find a way to report some income.  The magic number is 35 years x $10,272 in today's dollars, or around $360,000 in lifetime income.  As a side benefit, there's also the "Earned Income Tax Credit" handout you may qualify for.

The rest of you?  Sorry about those payroll taxes.  We gotta spread the wealth around.