When discussing what type of tax is used as income by retired people and people with disabilities, the answer often centers around Social Security taxes. These taxes are collected during a person’s working years and later fund benefits for retirees and individuals with disabilities. As of 2025, changes in retirement credits, cost-of-living adjustments, and new Social Security tax thresholds are reshaping how Americans in these categories receive and manage their income.
Understanding How Social Security Taxes Fund Income
Social Security remains the most critical source of income for both retired Americans and those with qualifying disabilities. The funding comes primarily from Federal Insurance Contributions Act (FICA) taxes and Self-Employed Contributions Act (SECA) taxes.
Employees contribute 6.2% of their wages, matched by employers, for a total of 12.4% dedicated to Social Security. Self-employed individuals must pay the full 12.4% under SECA. These contributions flow into the Social Security Trust Fund, which then pays benefits.
For millions of seniors and people with disabilities, these tax-funded payments form the backbone of their monthly income.
Key Points Summary – Quick Takeaways
- Social Security is funded through FICA and SECA payroll taxes.
- Retired people and individuals with disabilities depend on these taxes for income.
- As of 2025, Social Security benefits rose 3.2% due to a cost-of-living adjustment (COLA).
- The taxable wage base increased to $174,000 in 2025, meaning higher earners contribute more.
- Disability Insurance (SSDI) eligibility requires prior tax contributions through covered work.
- A debate continues in Congress on raising payroll tax rates to secure Social Security’s future.
How Retirement Income Is Taxed and Distributed
The Role of Payroll Taxes
Payroll taxes provide the funding that pays retirees. Workers contribute throughout their careers, and these contributions translate into credits. In 2025, individuals earn one credit for each $1,730 in wages, up to four credits annually. Most people need 40 credits to qualify for retirement benefits.
Distribution of Benefits
Social Security then pays benefits calculated from a worker’s average indexed monthly earnings. The formula favors lower-income workers, ensuring fairer distribution. Retirees who delay claiming until age 70 receive higher payments.
Taxation of Benefits
Not all retirees and disabled individuals escape taxation. Depending on total income, up to 85% of Social Security benefits may be taxable at the federal level. Many states, however, exempt these benefits entirely.
How Disability Benefits Depend on Tax Contributions
Disability income from Social Security Disability Insurance (SSDI) also relies on the same payroll taxes that fund retirement benefits. Eligibility requires sufficient work credits, with younger workers needing fewer credits than older ones.
For example:
- A 28-year-old may qualify with 18 credits.
- A 50-year-old might need 28 credits.
- A 62-year-old would require closer to 40 credits.
These rules ensure that individuals who contributed taxes while working receive income support if they become disabled.
2025 Updates Affecting Retirees and Disabled Individuals
1. Higher Wage Base for Social Security Taxes
The maximum amount of earnings subject to Social Security tax increased from $168,600 in 2024 to $174,000 in 2025. This means higher-income earners are contributing more.
2. COLA Adjustment
In January 2025, beneficiaries saw a 3.2% cost-of-living adjustment (COLA). This protects retirees and disabled individuals against inflation, raising the average monthly retirement benefit to $1,962.
3. Earnings Test Limits Raised
Those receiving benefits but still working face an “earnings test.” In 2025, the annual exempt amount rose, allowing retirees under full retirement age to earn more before benefits are reduced.
4. Debate Over Payroll Tax Increases
Lawmakers are considering raising the payroll tax rate above 12.4% to extend Social Security’s solvency beyond 2034. Proposals suggest gradually lifting the rate or removing the taxable wage cap altogether.
Breakdown: Taxes That Fund Income for Retirees and Disabled People
| Tax Type | Applies To | Rate in 2025 | Purpose |
|---|---|---|---|
| FICA | Employees | 6.2% (matched by employer) | Funds Social Security benefits |
| SECA | Self-employed workers | 12.4% | Covers both employer and employee share |
| Medicare (part of payroll taxes) | Employees & self-employed | 1.45% employee / 2.9% self-employed | Funds hospital insurance (not income) |
Only the Social Security portion of payroll taxes directly funds income for retirees and disabled individuals. Medicare taxes, while also deducted, support healthcare and not monthly income payments.
Why This Tax Structure Matters in 2025
- For Retirees: Rising inflation has made reliable income critical. Payroll taxes ensure steady Social Security checks.
- For Disabled Individuals: SSDI provides essential support for those unable to work, and this would not exist without prior payroll tax contributions.
- For Policymakers: The Social Security Trust Fund faces long-term deficits, sparking debates on reforms.
Alternative Income Sources for Retirees and Disabled People
While Social Security dominates, other programs and retirement income streams interact with taxes:
- Supplemental Security Income (SSI): Funded by general tax revenues, not payroll taxes, and provides aid to low-income disabled individuals.
- Pensions: Some public pensions are partially tax-funded but separate from Social Security.
- 401(k) and IRA Withdrawals: Retirement accounts are subject to income taxes but are not funded through payroll taxes.
This distinction matters: Social Security is unique because its funding is directly tied to what type of tax is used as income by retired people and people with disabilities—namely, payroll taxes.
Challenges Facing Social Security in the Coming Decade
Trust Fund Depletion
The Social Security Administration projects the trust fund could be depleted by 2034 without changes. Payroll taxes would still cover 80% of benefits, but reductions may occur.
Rising Life Expectancy
People live longer, increasing the years they collect benefits. This puts pressure on payroll tax contributions.
Disability Claims Growth
Economic downturns or health crises can spike disability claims, stressing SSDI funding.
Policy Solutions
- Raising payroll tax caps further
- Gradually increasing contribution rates
- Adjusting full retirement age
- Diversifying funding beyond payroll taxes
Common Misunderstandings
- Myth: Benefits come from general federal taxes.
Fact: They come from payroll taxes dedicated to Social Security. - Myth: Disabled individuals receive SSI and SSDI from the same fund.
Fact: SSI is funded by general revenue, while SSDI relies on payroll taxes. - Myth: Higher-income individuals don’t pay Social Security taxes.
Fact: They pay up to the annual wage base limit, which is $174,000 in 2025.
Practical Tips for Beneficiaries
- Check annual Social Security statements to confirm work credits.
- Stay updated on COLA changes to anticipate income shifts.
- Plan withdrawals from retirement accounts to manage tax liability on Social Security benefits.
- Ensure employment history is correctly recorded, as missing credits affect eligibility.
Frequently Asked Questions
Q1: What type of tax is used as income by retired people and people with disabilities?
It is the Social Security payroll tax, collected under FICA and SECA, that funds retirement and disability income.
Q2: Are Social Security benefits always tax-free?
No. Depending on your combined income, up to 85% of Social Security benefits may be taxable at the federal level.
Q3: Do all states tax Social Security benefits?
No. Most states exempt these benefits entirely, but a handful tax them partially.
Conclusion
Understanding what type of tax is used as income by retired people and people with disabilities is essential in 2025. Payroll taxes, through FICA and SECA, are the foundation of Social Security. They provide a safety net that ensures retirees and disabled individuals have a reliable income source, even as debates over the program’s long-term future continue. Staying aware of changes allows beneficiaries to prepare, plan, and protect their financial well-being.
Disclaimer: This content is for informational purposes only and does not provide financial, legal, or tax advice. For guidance specific to your situation, consult a qualified tax professional or financial advisor.