There are expected changes to the Social Security program. Every year, minor adjustments are made to help keep the program relevant and accessible to beneficiaries, but in 2025, due to the presidential election, there may be a change that few expect.
President-Elect Trump stated during his campaign that if elected, he would eliminate the federal income tax on Social Security retirement benefits.
As a campaign promise, this sounded really good to his new constituents, especially since retirees make up a large portion of his base, but if implemented, the same people clamoring for tax abolition will be the ones most affected.
The Cost of Eliminating the Federal Income Tax from Social Security
To determine whether this is a good idea, we must first perform some mathematical calculations. According to Social Security Administration (SSA) data, nearly 47.3 million people received Social Security retirement benefits as of the end of 2021, with an average annual payout of $21,228. The total payments amount to slightly more than $1 trillion.
If we make some tax assumptions, such as that 75% of those benefits (approximately $753 billion) were taxed and that the amount was divided evenly between two groups: one with 50% taxable benefits and another with 85%. Let us also assume that the 50% group pays 12% tax and the 85% group pays 24%.
Calculating the numbers, the 50% group would save approximately $45.18 billion in taxes, while the 85% group would save approximately $90.35 billion. This amounts to approximately $135.53 billion in tax savings.
To put it in perspective, that represents approximately 2.7% of total federal revenue. So, if Social Security benefits were not taxed, the government’s revenue would be reduced by that percentage.
While there are a lot of assumptions, the numbers appear to support the tax exemption in this scenario. If this were to become a reality, the extra money that retirees would receive could change their lives. It would stimulate the economy and allow for increased spending on non-essential items.
However, the sad reality is that most retirees do not have enough retirement savings, and many have no private savings at all, leaving them almost completely reliant on Social Security benefits. People may be surprised to learn that Social Security benefits are not taxed on their own; rather, they are taxed as part of combined income.
According to the SSA, only about 40% of Social Security recipients are required to pay federal income taxes on their benefits, which is significantly lower than the previous math suggested.
Your “combined income” is calculated by adding your adjusted gross income, nontaxable interest (such as bond interest), and ½ of your Social Security benefits. Once all of this is added up, you can determine whether or not your income will be taxed.
If you file a federal tax return as an individual and your total income falls between $25,000 and $34,000, you may be required to pay income tax on up to half of your benefits. If it exceeds $34,000, up to 85% of your benefits could be taxed.
If you file a joint return with your spouse and have a combined income of $32,000 to $44,000, you may be required to pay income tax on up to 50% of your benefits. If it exceeds $44,000, up to 85% of your benefits could be taxed.
Because approximately 60% of Americans do not have to pay federal income taxes on their Social Security income, this means that the majority of them live solely on their Social Security benefits or earn less than $25,000 per year ($32,000 for couples filing jointly). Given that this is the case, only the wealthier taxpayers, who already do not require additional income, would benefit from this tax cut.
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