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and have yet to be adjusted for inflation, meaning that many more beneficiaries are subject to tax because of these outdated thresholds.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.

Another perspective should be considered in the debate over taxing Social Security benefits. There are two primary arguments against taxing these benefits. The first, which motivates politicians like Donald Trump, is that seniors shouldn’t have to pay taxes on benefits they already funded through payroll taxes during their working years. This argument is made even more compelling by the fact that around 10% of seniors live in poverty. For those just above the poverty line but still struggling, taxing these benefits can make budgeting even more challenging.

However, if tax thresholds were adjusted for inflation, the vast majority of beneficiaries would not be taxed. Those who would still pay taxes on their benefits tend to be high-net-worth individuals who may not have contributed their fair share of Social Security taxes while in the workforce. But what does “not paying their fair share” mean? All workers earning under $132,900 per year pay 12.4% of their income into Social Security—split evenly between the worker and their employer. However, those earning above this threshold only have their income taxed up to that cap.

By lifting this income cap, the federal government could ensure the long-term solvency of Social Security while also expanding benefits. For example, this reform could fund a $1,300 benefit increase for seniors currently receiving less than $16,000 annually—a group that makes up nearly 30% of all beneficiaries. Expanding benefits in this way would reduce the need for taxation on Social Security, though it wouldn’t entirely solve the problem of ensuring seniors have adequate retirement income.

At the same time, the President-elect’s plan to eliminate taxes on Social Security benefits doesn’t fully address this issue either. While it would increase net incomes for some seniors, as the data below shows, it wouldn’t drastically alter the financial situations of most beneficiaries.

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 threshold, meaning that up to 85 percent of 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 beneficiary can use the test that is most advantageous 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.