In recent consumer seminars, one of the most common questions we are getting is the question of tax on Social Security benefits. Currently, benefits are taxed based on a complicated formula that presents opportunities for middle-income clients and advisors who understand the taxation formulas and how to coordinate Social Security income with other income sources. This tax structure has existed since the 1983 amendments and was updated in 1991, such that up to 85% of benefits are currently taxable as ordinary income. In the event taxation of Social Security benefits was eliminated, those who delayed benefits would experience a substantial additional benefit in the form of tax savings. We don’t expect that to happen. Here’s how we’re answering the question:

  • Social Security is already on unstable financial footing. The most recent Trustees Report projections suggest it will be out of money in 2033, with all beneficiaries receiving a 21% benefit cut in the absence of legislation. We don’t believe the full benefit cut will materialize, but conversely we don’t believe meaningful benefit increases will take place, especially for high-income earners.
  • Tax on Social Security benefits goes right back into the Social Security and Medicare trust funds. The Tax Foundation (Trump Social Security Tax Proposal: Details & Analysis) estimates that eliminating benefits taxation would speed up trust fund depletion by approximately two years for the Social Security OASDI trust fund and six years for the Medicare trust fund.
  • Eliminating tax on benefits would disproportionately benefit high-income earners. Low earners currently don’t pay tax on benefits due to the provisional income formula and taxation thresholds.  
  • We see two potential paths forward. If taxation of Social Security benefits were eliminated, we would expect corresponding cuts to the benefits of higher-income people, or the introduction of other taxes specifically designed to offset the lost revenue. A second possibility is some modification of the taxation formula for benefits. A few years ago, thresholds of $50,000 for single people and $100,000 for married filing jointly were proposed. To the extent the thresholds in the existing formula have not been indexed since inception, we could see the introduction of new thresholds, similar to that proposal, or indexing of the existing thresholds so that low to middle-income people experience less tax on their benefits.

Ultimately, changes to the system are inevitable, but we don’t expect to see any change that could be perceived as disproportionately benefiting wealthier people. Advisors who understand the taxation of Social Security benefits and the coordination with other retirement income streams are currently and will continue to be well-positioned to add substantial value to their clients' retirements.