Social Security is facing some serious financial challenges. And if lawmakers don't step in soon, many retirees who rely on those benefits are likely to suffer.
In coming years, Social Security expects its primary funding source -- payroll tax revenue -- to shrink as baby boomers start to retire en masse. The program can tap its trust funds for a while to keep up with scheduled benefits in the absence of adequate payroll tax revenue. But once those funds run dry, benefit cuts will be a distinct possibility.
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Recent projections estimate that Social Security's trust funds will be out of money in 2034. So at this point, we could be just a decade away from benefit cuts if lawmakers don't intervene.
Several solutions have been floated to address Social Security's fiscal woes. Some proposals include pushing back full retirement age and raising the wage cap for payroll taxes.
But a recent proposal published by the Center for Retirement Research at Boston College suggests that limiting the tax benefits associated with IRAs and 401(k) plans could help pump more money into Social Security. And while that's a necessary thing, taking away those tax breaks could hurt savers in a huge way.
Is your IRA or 401(k) tax break at risk?
Savers who fund a traditional IRA or 401(k) plan get to shield a chunk of their income from taxes. This year, IRA contributions max out at $7,000 for savers under age 50 and $8,000 for those 50 and older. The limits for 401(k)s are even higher -- $23,000 and $30,500, respectively.
Clearly, there's benefit to being able to not pay taxes on up to $30,500 of earnings. The problem though is that the aforementioned tax breaks also shield income from payroll taxes, which are needed to fund Social Security. By limiting the tax breaks given by IRAs and 401(k), lawmakers can help shore up Social Security's finances.
This proposal also argues that it's high-income individuals who are most likely to benefit from the tax breaks currently offered by IRAs and 401(k). As such, removing those tax incentives wouldn't necessarily impede their ability to save.
However, it's very easy to make the argument that for lower and middle earners, removing or limiting the tax incentives associated with IRAs and 401(k) would, in fact, make it harder for workers to save for retirement. Plus, losing out on those tax breaks might disincentivize workers as a whole to participate in these plans. So while this proposal might help pump more money into Social Security, it might also result in a major decline in personal retirement savings.
Will lawmakers bite?
Just because there's a proposal out there to change the way IRAs and 401(k)s work for the benefit of Social Security doesn't mean lawmakers will get on board with this change. However, the reality is that something needs to be done to prevent Social Security cuts, and pretty quickly.
Pushing back the full retirement age has been hailed as a solution that, at least in theory, affects workers of a certain age equally, regardless of income. As such, it remains a popular one, and is likely to remain a more popular idea than cutting the tax breaks associated with IRAs and 401(k) plans.
Either way, lawmakers may have to resort to measures that have a negative impact on workers one way or another if they want to avoid Social Security cuts. So workers should keep tabs on the situation and brace for some changes that unfortunately may not be so favorable.
