Repeal Income Tax on Social Security? What Retirement Experts Think of New Bill

Social security card puzzle and a hundred dollar bills

What You Need to Know

The You Earned It, You Keep It Act would end federal income tax on Social Security benefits while phasing out the payroll tax cap.
Retirement planning experts say the fundamentals of the proposal are sound but a broader approach may ultimately be needed.
While passage in the short term appears unlikely, the legislation could serve as a stepping stone in future Congresses.

The two core components of the You Earned It, You Keep It Act — doing away with taxes on Social Security income and phasing out the cap on work earnings subject to Social Security payroll taxes — seem fairly simple on their face, but retirement industry experts say the bill recently introduced by two Democratic lawmakers requires a closer look to understand its real potential effects.

According to the lawmakers, the proposed reforms would make the Social Security program fairer while also pushing out the projected insolvency date of the key Social Security retirement trust fund to 2054 — 20 years beyond the current projection of 2034.

In a new series of interviews with ThinkAdvisor by phone and email, a stable of retirement planning experts offered up their assessment of those propositions — and the results are decidedly mixed.

What the experts all agreed on, though, is the clear and pressing need for lawmakers to start some difficult conversation about how to “save” Social Security, and they credited Reps. Angie Craig, D-Minn., and Yadira Caraveo, D-Colo. for doing just that.

Pulling Only One Lever So Strongly Is Risky

Michael Finke, professor and Frank M. Engle Chair of Economic Security at the American College of Financial Services, says he hopes the You Earned It, You Keep It Act will be “a first salvo in a necessary bipartisan negotiation about how to fix Social Security.”

See also  Are advisors arming themselves with RI knowledge?

“Politicians aren’t going to allow an automatic cut of benefits in 2033,” he argues. “There are only two ways to prevent the benefit cuts — raise taxes or reduce benefits. No politician wants to cut benefits, so it seems inevitable that taxes will go up.”

Finke argues that an ideal solution would be some combination of raising the amount of income subject to taxes, increasing the net income tax on capital gains, modifying the inflation adjustment to more accurately reflect retiree spending, and increasing the full retirement age.

“This proposal pulls one of these levers much further than most policymakers would recommend by significantly increasing the tax burden on higher earners, and it offers a tax break on income for beneficiaries to make it politically popular,” Finke says. “The tax code already places a higher tax burden on earned income and this will push tax rates to a point that could impact economic growth.”

Finke says Social Security is already a highly progressive system, since lower earners receive a much higher income as a percentage of their contributions. This proposal would inherently make Social Security even more progressive.

“I’m not confident that we can get a good bill passed in the current political environment, but it would be far better to pass something now than wait until the cuts and tax increases need to be even more extreme in 2033,” he concludes.

Not Exactly a Win-Win

Summarizing his response to the proposal, PGIM DC Solutions’ David Blanchett says he is “generally in favor of any reasonable proposal to shore up the funding of the Social Security retirement system.” However, he sees it as a “little bit disingenuous” for the bill’s sponsors to describe it entirely as a “win-win,” because “someone is going to end up footing the bill to address the current deficits.”

See also  What do payout envelopes look like?

“While I’m not opposed to the idea of eliminating tax on Social Security benefits generally, it’s worth noting that, given the structure of how benefits are currently taxed, it’s only going to be retirees with higher income levels who are actually taxed on the benefits to be begin with,” Blanchett says. “I’d probably like the bill more if this particular provision was eliminated, because it actually makes the situation worse than it would be than if we just raised taxes on higher income Americans to close the deficit.”

With respect to the bill’s prospect for passage, Blanchett says that’s anyone’s guess, but the safer bet is probably to assume it won’t make it out of the House and Senate this year.

“I’m honestly not sure whether or not this is going to make it through Congress,” he says. “I think it’s easier to suggest it’s unlikely to make it, given the divided political climate and how the costs are being apportioned.”

Blanchett further notes that there are quite a few levers available to close the existing funding gap beyond just raising taxes on some cohort of Americans. For example, Congress could change the claiming formula by age (e.g., make people work longer) or reform how benefits increase in retirement.

“While just raising taxes is obviously one way to do it, the existing benefit formula is already relatively progressive,” he says. “This would effectively just make it even more progressive from a tax perspective. Now, I think that’s fine, given the fundamental role of Social Security benefits, but I’d like to see other potential aspects of the existing system adjusted as well — increase claiming ages in particular.”

See also  How to File a Life Insurance Claim With United Home Life Insurance Company