The danger of a temporary elimination of taxes on Social Security benefits

It would offset one of the greatest contributors to our current retirement success

It’s being reported that President Trump’s tax plan will fulfill his pledge to eliminate taxes on Social Security benefits – but only for four years. Eliminating benefit taxation is both unnecessary for retirees’ financial security and harmful to Social Security’s finances. But making the elimation of benefit taxation temporary could actually harm some Americans’ retirement security.

Since 1983, part of Social Security benefits have been subject to income taxes. In 1983 Congress had half of social security benefits taxable for individuals with incomes over $25,000; the proceeds are redirected to Social Security to bolster the program’s lagging finances.

in 1993, Congress made up to 85% of social security benefits taxable. The incremental revenue was redirected to Medicare.

Currently, Social Security receives about 5% of its total revenues from benefit taxation. Eliminating those benefit tax revenues would cost Social Security a little over $1 trillion over 10 years, pushing forward the date of the trust fund’s insolvency and worsening funding gaps in perpetuity.

Which is why the Trump administration is reportedly considering eliminating Social Security benefit taxes for just four years, which would cover the remainder of President Trump’s term in office. At the end of four years benefit taxes would be restored in full. That would reduce the cost to a more affordable $312 billion. (Sorry, “affordable.” When the annual budget deficit is already about 6% of GDP, all these terms are relative.)

Temporary tax cuts are a common budgetary strategy: assuming the tax cuts expire lowers the reported budgetary impact, making the tax cut legislation easier to pass. But the hope is always that the tax cut will get extended at the end of its legislated life.

But what if it doesn’t? Or, more importantly, what if Americans think the elimination of Social Security benefit taxes will only be temporary?

That can have some real effects on seniors’ behaviors, and not in ways that would enhance retirement security.

A little-reported story is that Americans are indeed retiring significantly later today than they did in the past. (Something critics back in the 1990s and early 2000s warned they couldn’t do, as I discuss in my new book, The Real Retirement Crisis.) Average Social Security benefit claiming ages were high in the early decades of the program, because benefits were not available before age 65 and because there was a steep benefit reduction for people who collected benefits while they were still working. However, once reduced benefits were offered at age 62 beginning in the early 1960s, average claiming ages fell. By 1995, the average American claimed benefits at about age 63.6.

At the time, some thought Americans could not work longer, due to age discrimination, declining health, and the paucity of available jobs.

However, beginning in the 2000s average Social Security claiming ages began to increase. By 2023, the most recent data available, the average American claimed benefits at age 65.2, a 1.6 year increase versus 1995. And, since Social Security benefits increase by about 7% for each year you delay claiming, Americans retiring today are receiving a monthly benefit boost of over 10%, for life.

That’s one reason Americans don’t face a retirement crisis.

But back to the temporary benefit tax cut. If Congress eliminates Social Security benefit taxation only for the next four years, middle- and high-income Americans approaching retirement age will have an incentive to claim benefits early in order to access that no-tax window of time. Someone aged 60, who might otherwise have waited five years to claim benefits at 65, might instead claim at 62 in order to receive a few years of tax-free benefits. (I thank financial planner Jim Mahaney for this insight.)

Since benefit taxation is restricted to middle- and upper-income retirees, earlier retirements wouldn’t be the end of the world. The median U.S. senior, as I have pointed out before, has the second highest disposable income in the world, according to the OECD.

But seriously, why mess with success? Why enact a tax cut that’s really not needed – again, second-highest income in the world, after tax-haven Luxembourg – that harms Social Security’s finances, and that would encourage Americans to retire early, thereby undercutting their retirement income security?