Social Security is our nation's most important social program, and whether you realize it or not, there's a very good possibility that you'll be at least somewhat reliant on its payout during your golden years to make ends meet. A 2018 Gallup survey found that 84% of nonretirees expect Social Security to be a major or minor part of their income, tying a 15-year high. This also jibes with the fact that nine out of 10 current retirees rely on their monthly payout to some degree to make ends meet, per Gallup.
However, the Social Security payout most working Americans will receive during retirement could be smaller than expected. According to the Social Security Administration, your benefit check is only designed to replace about 40% of the average workers' wages during retirement.
What's more, Social Security beneficiaries could be exposed to federal and/or state taxation, which is a sore subject among seniors. But there had been hope recently that the pain associated with the taxation of benefits would ebb a bit.
Trump's hallmark tax plan provides few benefits to retirees receiving Social Security
In December 2017, President Trump signed into law what may perhaps go down as his hallmark piece of legislation during his presidency, the Tax Cuts and Jobs Act (TCJA). It represents the biggest overhaul of the U.S. tax code in more than three decades. It wound up permanently lowering the peak marginal corporate income tax rate to 21% from 35%, while also providing income-tax breaks for individual taxpayers, which are scheduled to end on Dec. 31, 2025. More specifically, it also provided modest hope to seniors that changes would reduce or eliminate their tax liability on Social Security benefits.
The Reagan administration enacted the last major overhaul of the Social Security program in 1983. Among the many changes was the introduction of the taxation of benefits in 1984. If a single taxpayer's modified adjusted gross income (MAGI) plus one-half of benefits exceeds $25,000, or $32,000 for a couple filing jointly, up to 50% of their Social Security benefits become exposed to federal taxation. A second tier was added in 1993 under the Clinton administration that allows up to 85% of Social Security benefits to be taxed for single taxpayers whose MAGI plus one-half of benefits exceeds $34,000, or $44,000 for a couple filing jointly.
There was initial hope that adjustments to the individual tax brackets, as well as switching to the Chained CPI from the Consumer Price Index for All Urban Consumers, would reduce federal taxation levels on Social Security. The Chained CPI's accounting of substitution bias -- i.e., consumers trading down to similar but cheaper goods and services -- means that inflation impacts the federal income tax brackets at a slower rate than in year's past. This was expected to help reduce recognized MAGI, thereby lowering the number of senior households exposed to the taxation of benefits. Unfortunately, this hope has proved fleeting.
According to an analysis from the nonpartisan Senior Citizens League, 46% of senior households surveyed paid tax on a portion of their Social Security benefits in 2018. Meanwhile, between 2015 and 2018, the average number of retired households owing tax on their benefits declined by just 1 percentage point, to 50% from 51%. In effect, the TCJA had virtually no impact on lessening the tax burden that roughly half of retired workers face on their Social Security benefits.
The taxation-of-benefits dilemma
Then again, this isn't entirely (or even chiefly) Trump's fault. Since both tiers of taxation were introduced in 1983 and 1993, the income thresholds haven't once been adjusted for inflation. In 1983, when the individual taxpayer threshold was set at $25,000, it was designed to affect only about 1 in 10 senior households. Similarly, when the second tier was added in 1993 at $34,000 for individual taxpayers receiving benefits, it affected fewer than 20% of all households. But after roughly 25 and 35 years of inflation, respectively, without adjusting the income thresholds, half of all seniors receiving benefits are now on the hook for some level of taxation on their benefits.
Additionally, as alluded to earlier, 13 states tax Social Security benefits to some degree. This means seniors could be taxed on their benefits federally, then essentially double-taxed by their state.
Seniors have been very clear that they don't support taxing Social Security benefits at all. A survey from The Seniors Center, a Washington-based nonprofit organization focused on senior issues, found that an overwhelming 91% of seniors don't think that their benefits should face federal taxation. But even with landslide support, Congress' hands are mostly tied when it comes to taxing Social Security payouts.
The 2018 report from the Social Security Board of Trustees notes that the program doesn't have enough revenue coming in to fund the current payout schedule through 2092 (i.e., the next 75 years). By 2034, Social Security's $2.89 trillion in asset reserves are expected to be completely gone, potentially requiring a reduction in benefits of up to 21%. The aggregate $13.2 trillion cash shortfall forecast between 2034 and 2092 includes the continued collection of revenue from the taxation of benefits. In fact, the taxation of benefits is expected to supply the program with $561 billion in revenue between 2018 and 2027.
So this revenue is absolutely vital to the Social Security program. Remove the ability to tax benefits, and it would almost certainly accelerate Social Security's cash shortfall as well as the projected arrival date of the asset reserve depletion. Yet, at the same time, removing the taxation of benefits -- or at the very least updating the income thresholds for inflation -- would provide middle-income seniors with a much-needed monetary boost.
Frankly, there's no easy fix to the taxation of benefits. But what is pretty certain is that the Trump tax cut isn't the fix that retired workers are looking for.