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The new questions and concerns clients may have about Social Security

SEP. 17, 2020

If you’re like many Americans, the Executive Orders (“Orders”) signed by President Trump on August 8, 2020, brought about mixed emotions. While the Orders provided American workers temporary relief in the form of a deferral of the employee’s share of payroll taxes from September 1, 2020 to December 31, 2020, President Trump also directed the U.S. Treasury to find a means of eliminating the employee share of payroll tax altogether beyond the December 31, 2020 deadline which has stirred up questions about the sustainability of Social Security and possible negative impacts that such a move may have on an individual’s overall retirement goals.

  • What exactly is the long-term impact of a payroll tax deferral?
  • What happens to the Social Security Program that we know today if the employee share of the payroll tax goes away completely?
  • If the sustainability of the Social Security Program is diminishing, what can American workers do to feel more at ease about their own retirement readiness?

These are questions top of mind for many individuals, including myself. While no one knows for sure what will happen to the Social Security Program in the future, I do know a couple of things for sure . . . this isn’t the first time that the sustainability of the Program has been called into question (meaning a more thorough and comprehensive approach is probably long-overdue). And secondly, there are a couple of things individuals can do to gain control over their own retirement readiness.  And who doesn’t like a little bit of control?

What is the long-term impact of the deferral of payroll taxes?

The Social Security Program is a trust fund established by the U.S. federal government that is funded with payroll taxes from both workers and their employers. When an individual earns compensation, a percentage of their payroll goes into the trust fund.[1] The assets within this trust fund are used to pay benefits to individuals and families to whom benefits are owed. If payroll taxes are deferred, then the delayed deposits further increase the rate at which the Program’s assets will be depleted and therefore not meet its future intended obligations.

It’s important to note that the Order provides for a deferral of employee payroll taxes, not a complete elimination of taxes. Therefore, as of now, payroll taxes deferred through December 31, 2020 will have to be fully repaid in tax year 2021 somehow. Additionally, the implications from the Order may be somewhat inconsequential seeing as many employers may not even implement the tax deferral at all as it is administratively burdensome.

What happens to the Social Security Program that we know today if the employee payroll tax goes away completely?

You may or may not recall but this is not the first time that the Program has been in jeopardy of not being able to fulfill its future obligations. In both 1977 and 1983, the Social Security Administration made substantial changes to the Program to ensure that it would be able to meet future benefit payments in full. So, while it may feel like these are uncharted waters, the Program trustees are well-equipped to make whatever changes deemed appropriate to ensure that the Program can continue to meet its future obligations.

As of the date of this article, the Program is able to pay full benefits through year 2035,[2] however beyond year 2035 trust reserves may be exhausted, and thus benefit payments would be administered on a reduced basis.[3] It’s also important to note that President Trump has stated that he does not want to eliminate the Program altogether and that elimination of the payroll tax might mean that the difference is made up from the general fund of government revenues.

What can American workers and savers do right now?

The average person will generally have a retirement income portfolio that is comprised of both government funds (i.e. Social Security) and personal funds (i.e. personal savings, qualified retirement plan, Individual Retirement Account (IRA)). While it’s completely reasonable to question the sustainability of the Program, it appears that it will take some time for any movement on these issues by Congress. With an upcoming presidential election, I imagine that changes to the Program will be tended to once the new president is chosen.

One thing you can do right now is save as much as you can in your employer sponsored qualified retirement plan. This is the most tax-advantageous means of personally saving for your own retirement. These plans allow you to make a pre-tax contribution, reduce annual taxable income, and allow for tax-deferred growth. Many of these plans will also provide for an employer matching contribution, meaning that if you contribute a certain percentage, your employer will match your contribution up to a certain percentage. By not taking advantage of the matching contribution, you are leaving retirement income on the table.

It’s also important to maximize contributions to your employer sponsored Health Savings Account (HSA) or Flexible Spending Account (FSA). These accounts allow you to contribute to the account on a pre-tax basis and pay for qualified medical expenses tax-free.[4] And if you don’t have access to an employer sponsored qualified retirement plan, then consider contributing to an IRA. An IRA contribution is also made on pre-tax basis and grows tax deferred.

 

[1] 6.2% employee tax, 6.2% employer tax

[2] Combined Old-Age and Survivor/Disability Insurance Trust Funds

[3] Employer payroll taxes are not impacted by the Order, only employee portion. Therefore, the contributions through employee tax will need to be recouped through further legislative changes. Actuarial Status of the Social Security Trust Funds, April 2020.

[4] Visit www.healthcare.gov for information on eligibility, contribution thresholds, coverage, and qualified medical expenses.

Disclaimers

  • This information is general in nature and is not intended to be tax, legal, accounting or other professional advice. The information provided is based on current laws, which are subject to change at any time, and has not been endorsed by any government agency.

    Neither Nationwide nor its representatives give legal or tax advice. Please have your clients consult with their attorney or tax advisor for answers to their specific tax questions.

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