It might not all be good news: Donald Trump’s plan to eliminate taxes on Social Security

In the 1980s, as union power was diminished and jobs were sent overseas, pensions began to be replaced by private retirement accounts like 401(k)s and Roth IRAs. Employers can reduce their tax burden as the funds paid into these accounts are deductible. As workers offered these retirement benefits begin to retire, their monthly payments, plus their Social Security benefits, may mean their income continues to be subject to taxation.

Donald Trump’s campaign promise

President-Elect Donald Trump campaigned to eliminate Social Security taxes at the federal level. While plenty of arguments support this action, it also creates some issues. The Social Security fund is currently insolvent, meaning more money is being taken out than being put in. The taxes on Social Security benefits help to fill the gap, and eliminating them would only widen it, further destabilizing a program that tens of millions of seniors rely on as their primary source of income.

An antiquated system for taxation

According to the Social Security Administration (SSA), about forty percent of Social Security beneficiaries pay taxes on their benefits. However, the income levels under which taxation is determined were set in 1984 and have yet to be adjusted for inflation, meaning that many more beneficiaries are subject to tax because of these outdated thresholds.

Below, you will find the income thresholds determining which Social Security recipients see their benefits taxed and what they would look like if they had been adjusted for inflation.

Some financial planners, like Jordan Gilberti, who serves as a senior lead planner and certified financial planner at Facet, see the fact that these thresholds have not been adjusted as a “stealth tax” as so few understand the mechanisms. In an interview with USA Today, Gilberti said that while many people realize that “Social Security gets taxed,” they often don’t know how, and when he explains the process, “people’s jaws would fall to the ground.” The US Census Bureau put the median household income for seniors at $50,290 in 2022. In other words, many of these households might not be paying taxes on their benefits if these thresholds were adjusted.

There is another perspective that should be brought into the debate. There are two main arguments as to why Social Security benefits shouldn’t be taxed. The first, and the one that motivates politicans like Donald Trump, is that seniors shouldn’t have to pay taxes on benefits their taxes (from their days in the workforce) helped to pay for. That argument is made more convicing by the fact that around ten percent of seniors live in poverty, and for those above the poverty line but struggling, taxing these benefits can make budgeting more challenging. But, if the tax rates were to be adjusted for inflation, the vast majority of beneficaires would not be taxed, and those that do, are high net worth individuals who may have not paid their fair share of Social Security taxes while they were in the workforce. Not paying their fair share? All workers who make under $132,900 a year pay 12.4 percent of their income in Social Security taxes (half of which is paid by the worker and half by their employer). However, those who make over this level, only have their income taxed up to that cut off. By lifting that income cap, the federal government would be able to ensure the solvency of Social Security for decades, and even offer a $1,300 benefit increase to seniors who recieve Social Security checks worth less than $16,000 a year; which happens to be nearly 30 percent of all beneficiares. By being able to expand benefits, the issue of taxation on Social Security becomes less of an issue, though it may not erase the problem of benefits ensuring seniors have the incomes they need to retire in diginity. At the same time, neither does the President-elect’s plan to elimated taxes on these federal benefits. Sure, incomes will rise, but as you will see below, they are not going to radically change the budgetary circuamstances of most beneficiares.

How do taxes impact retirement benefits?

Based on the rules above, imagine that a person receives a $1,920.48 check from Social Security (the average for retired workers in August 2024) and $2,000 from their Roth IRA (which the retiree paid taxes on when the funds entered the account). Before anything else, we must determine this retiree—let’s call them Jerry—Jerry’s combined income, which consists of their adjusted gross income, any income from interest, and half of the value of your Social Security benefits for the year. Jerry’s adjusted gross income is $24,000, he earns no income from interest, and half of the value of his Social Security benefits adds up to $11,522.88, making his combined annual income, $35,522.88. Jerry’s combined income is a little over $1,500 above the Social Security’s threshold, meaning that up to 85 percent his benefits could be subject to tax.

Next, to determine how much of one’s benefits can be taxed, there are three tests used, and the benefciciary can use the test that is most advantagous to their pocketbook.

Test one: 85% of Jerry’s Social Security benefits:

The second test, takes 50 percent of Jerry’s benefits and 85 percent of his combined income over the upper threshold ($34,000), to determine how much of his benefits can be taxed:

The third test takes 50 percent of Jerry’s income over the first threshold ($25,000), plus 35 percent of Jerry’s combined income above the second threshold ($34,000):

For Jerry, the third test provides him with the lowest possible taxes on his benefits.