1 Change Donald Trump Wants to Make to Social Security That Could Have a Surprising Effect on Retirees

Source The Motley Fool

With President-Elect Donald Trump set to take the Oval Office later this month, millions of Americans can expect a slew of changes in the pipeline for the next four years.

Social Security has been a hot-button issue for years, and Trump has already made big promises about the future about the program. However, there's one change he's proposed that could have serious unintended consequences for retirees.

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Millions might benefit from Trump's tax promises

During his presidential campaign, Trump promised widespread tax cuts -- from no tax on tips or overtime to cutting federal taxes on Social Security benefits. The latter, specifically, could have a direct impact on millions of retirees, with around 40% of those collecting benefits owing taxes on them.

Stack of Social Security cards.

Image source: Getty Images.

Sometimes, these taxes can take a significant bite out of your budget. Your federal taxes are determined by a figure called your "combined income," which is your adjusted gross income (such as 401(k) withdrawals) plus half of your annual Social Security benefit and any nontaxable interest.

Individuals with a combined income of more than $34,000 per year (or $44,000 per year for married couples filing jointly) will owe federal taxes on up to 85% of their benefits.

Eliminating this tax may sound promising on the surface, as it could put more money back into the pockets of millions of Social Security recipients. That said, it could also cause a bigger problem in the process that could sting even more.

An unintended consequence of tax cuts

While tax cuts could benefit retirees in the short term, they could also contribute to Social Security's cash shortfall and the depletion of the trust funds.

This cash shortfall is an ongoing problem that's been on Washington's radar for years, but it's becoming more pressing. Social Security's two trust funds (one reserved for retirement benefits and the other covering disability benefits) are quickly running out of money, and tax cuts could worsen the problem.

Social Security is primarily funded by taxes -- including payroll taxes paid by workers and employers as well as income taxes on benefits paid by retirees. In recent years, though, these taxes have not been enough to fully fund benefits, resulting in a deficit.

To bridge the gap, the Social Security Administration has been dipping into its trust funds to continue paying out benefits in full. But once both trust funds run dry (which is expected to happen by 2035, according to the Social Security Administration's latest estimates), there will only be enough income to pay out around 83% of scheduled benefits.

What does this mean for you?

Currently, benefits could be slashed by around 17% by 2035 -- assuming Congress doesn't find a solution before then. But if taxes on benefits are eliminated, that could force the Social Security Administration to pull even more from its trust funds, causing them to run dry sooner than 2035.

In fact, eliminating federal income taxes on benefits could increase Social Security's cash shortfall by $2.3 trillion over the next decade, according to a report from the nonpartisan Committee for a Responsible Federal Budget. The study also estimated that eliminating the tax could cause the trust funds to run out three years sooner than expected.

If benefits are reduced by 17% as is currently projected, that could slash the average retiree's checks by close to $4,000 per year. But if taxes on benefits are eliminated, that would give Social Security one less income source to continue paying out future benefits -- meaning payments could potentially be reduced even more than expected.

To be clear, Trump's proposed tax cuts are not a reality yet. He'll still need to gain approval from Congress before anything can take effect -- which may be difficult considering lawmakers are already struggling to find a solution to Social Security's cash shortfall, and eliminating taxes on benefits will only tighten that timeline.

Only time will tell what's in store for Social Security. While Trump's tax promises could benefit many retirees in the short term, they could spell more trouble down the road.

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