President Donald Trump's Plan to End Social Security Benefit Taxation Would Solve 1 Problem While Exacerbating Another

Source The Motley Fool

You pay Social Security taxes throughout your career so you can enjoy guaranteed monthly checks in retirement. But when you retire, you could have to pay taxes on a portion of your benefits, too. It's a major pain point for seniors, many of whom don't have a lot of personal savings to supplement their checks.

President Donald Trump has asserted his belief that seniors shouldn't pay Social Security benefit taxes, and there are plenty of retirees who feel the same. There's a bill in the House now that, if passed, would completely eliminate the tax, providing significant gains to many seniors. But there's a hidden cost that can't be ignored.

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Trump's plan would end double taxation

Many seniors feel they shouldn't owe taxes on their Social Security benefits because they already paid Social Security payroll taxes on their income during their careers. The current benefit tax formula exposes up to 85% of your Social Security benefit to ordinary income tax, which, depending on your income, could amount to thousands of dollars per year.

Those whose provisional incomes -- adjusted gross incomes (AGIs), plus nontaxable interest from municipal bonds, and half your annual Social Security benefit -- are at or below $25,000 for a single adult or $32,000 for a married couple are exempt from this tax. But since these thresholds aren't indexed for inflation, more seniors owe them each year as average incomes and Social Security benefits rise.

The Senior Citizens League (TSCL), a nonpartisan senior group, estimates that eliminating this tax would save the average senior household a little over $3,000 per year. That could cover several weeks of expenses for many families. However, it's unclear how long these gains would last.

Social Security's trust funds are running out of money

The biggest concern about eliminating Social Security benefit taxes is that it may cause the program to run out of money more quickly. Right now, Social Security benefit taxes are one of just three funding sources for the program, the other two being Social Security payroll taxes and interest earned on the program's trust funds.

Social Security payroll taxes aren't going anywhere, but the trust funds are rapidly disappearing. The program has been spending more money than it's taken in since 2021. So far, it's been able to continue paying all scheduled benefits by using the money in the trust funds. That won't be an option forever, though.

The latest Social Security Trustees Report projected that the program's trust funds would be depleted in 2035. However, this was published prior to the passage of the Social Security Fairness Act, which increased benefits to 3.2 million seniors. That accelerated the trust fund depletion deadline by about six months. If it continues on as is, Social Security will only be able to pay out about 77.7% of scheduled benefits once the trust funds run out of money.

If Trump succeeds in eliminating benefit taxes, this deadline will move up even sooner. But this isn't a guarantee that seniors will see benefit cuts. It's likely that the government will enact some sort of reform to keep Social Security solvent before cuts are necessary. However, it's not clear when these reforms will take effect or what they'll look like.

The less time there is until the trust fund depletion date, the fewer options there are to resolve the problem. This isn't to say Social Security benefit taxes shouldn't be eliminated. But it's something Congress will definitely have to weigh when deciding whether to pass the bill that currently sits in the House.

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