You may have heard that there’s an election coming up. And maybe you’re planning your own event – your retirement. Does one affect the other? Will the election affect your retirement planning? Trying to read the political tealeaves is rarely productive; still, there are some general considerations about the upcoming election that should factor into your retirement planning. Specifically, unless Congress acts after the November election, trouble is potentially brewing for two key retirement planning issues. First, taxes – both income and estate tax. And second, Social Security benefits. The election outcome may affect how you plan your retirement income strategy around these two issues.
Tax Troubles from Sunsetting
Irrespective of whether Congress goes red, blue or stays purple, they have a significant tax challenge on their hands. Many provisions of the Trump administration’s Tax Cuts and Jobs Act will sunset on January 1, 2026. There are three key areas that should concern a prospective retiree about these baked-in changes to federal tax law.
– Particularly for higher income individuals, income taxes will go up. The top rate climbs from the current 37 percent back up to 39.6 percent. And, the standard deduction drops. It’s more complicated than this, but it all translates to higher income taxes.
– Many closely held businesses will see a tax increase because the 20 percent qualified business income tax deduction will expire. The C Corp tax rate remains the same at 21 percent, but the tax benefit for many pass-through companies (partnerships, LLCs, and S Corps) will expire. This lost deduction will particularly affect service businesses.
– Estate taxes on the affluent will reappear as the $13.61 million estate tax exemption is cut in half. The 40 percent estate tax will apply to many more estates because of the lowered exemption level.
Big picture, if Congress doesn’t pass legislation this year or in 2025, federal taxes will generally revert to the tax regime that was in place during the Obama Administration.
Will Congress act? Obviously, we don’t know. But some educated guesses can be attempted, depending on the outcome of elections in November.
If there is a blue sweep, and the Democrats win both Congress and the White House, taxes on the affluent and wealthy are likely to go up. The Biden Administration’s green book lays out a laundry list of areas to tackle. On the income tax side, the focus is on having those with incomes in excess of $400,000 pay more in income taxes. On the estate tax side, there are a number of changes that could significantly reform estate taxes and have them apply to more families and individuals. The exemption could go even lower, and a number of tax saving techniques such as GRATs and grantor trusts could be curtailed. And as far as businesses, there seems to be some recognition that flow-through entities deserve tax relief to help them stay competitive with larger C Corps. There is talk of retaining some aspects of the qualified business income deduction for flow-throughs. Still, since a rate increase for C Corps is being proposed by the current Administration, overall rates on businesses may go up.
If there is a red wave instead, with Republicans taking over, the tax situation is not quite as clear. It’s fair to assume there will be a push to extend or even make permanent the provisions of the Tax Cuts and Jobs Act. This was President Trump’s landmark legislation, and its continuation would be seen as a victory. At the same time, considering the massive federal debt and the concerns of many deficit hawks in the Republican ranks, significant tax cuts seem unlikely. There may be tweaks, such as lowering the estate tax on family businesses, but an overall tax reduction is not in the cards.
If the election brings us more of the color purple – a divided Administration and Congress – the picture is fuzzier. Doing nothing, in other words Congress fails to pass tax legislation, is effectively a victory for the Democrats. Sunsetting will automatically kick in in 2026, and taxes will increase from current levels. This may be a hollow victory for Democrats since Americans will feel the sticker shock of raised taxes in an inflationary economy. So, Democrats may well want to compromise. More likely than not, the two political parties will hammer out some kind of bargain that neither will be happy with. Some of the current tax benefits will be extended; some won’t.
Social Security’s Dilemma
Timing is ticking for Social Security benefits
The Social Security Trustees Report published just yesterday. Although it is an improvement over last year’s report, it still isn’t pretty. The trustees project depletion of the trust fund by 2035 and a reduction of retiree benefits as the result. These projections are more than mere actuarial guessing. This important retirement benefit is legislatively in a position similar to the sunsetting of taxes. If nothing is done about sunsetting of the Tax Cuts and Jobs Act, taxes will go up for Americans. If nothing is done about Social Security funding, benefits will go down for Americans. When the Social Security trust fund depletes in approximately a decade, retirees will, by law, suffer a pro rata haircut in their benefits. The benefits cannot be paid out of the general fund without Congress proactively changing the law. So, when politicians declare they won’t touch Social Security, they are effectively conceding that in a few years benefits will go down, currently by a projected 17 percent. This will not be a sustainable position politically, and that will eventually force Congress’s hand to do something.
Irrespective of whether the federal government goes red, blue or stays purple, Social Security will likely be addressed sometime after the election. This is an issue that doesn’t have a quick fix and, whatever is decided, will have repercussions for retirees for years to come. Since a lot of money is involved, and a lot of experts have been weighing in on this issue for years, there’s no way to predict exactly how Social Security will be reformed. The 2024 trustees report offers a little bit of extra time as compared to 2023, but we’ve seen how these projections can change for the worse quickly.
Despite the uncertainty of where Congress may take this challenge, a few guesses can be made:
– In reforming the system, it’s not likely that current Social Security retirement income benefit recipients will experience substantial, if any, cuts to their benefits. This would be politically toxic.
– Near-retirees are also likely to avoid much of the pain of major reform. Still, as a way to fund Social Security, the full retirement age may be pushed out from age 67 to something closer to age 70. If history is any indicator, this change will take years to transition.
– Current workers may be the first to feel the pinch of reform in that their employment taxes may go up. While the 6.2 percent FICA tax currently shuts off at $168,600 of income, the 1.45 percent Medicare tax does not have a wage cap. In fact, the rate actually increases for higher income individuals. Social Security may go the route of Medicare and see some kind of changes to the wage cap in order to generate more employment taxes to fund benefits.
– Another solution may be to tax Social Security benefits more heavily. Currently, from zero to 85 percent of benefits are subject to income tax, using a formula that is based on income. This tax regime could change as a way to increase funding for the ailing Social Security system. And more taxes on benefits means less net benefits for the retiree.
– The longer it takes Congress to address Social Security underfunding, the more drastic the measures that will be needed to shore up the system.
Planning Your Retirement
For most near-retirees, an election will not influence whether and when they retire. Retirement is a deeply personal decision. But what an election can affect is the financials behind funding of your retirement plan. If your taxes are going to go up, that needs to be factored into budgeting how much you can afford to spend each year in retirement. If Social Security benefits are going down, again, it affects your retirement income.
Following this upcoming election, Congress will need to address taxes and Social Security. Otherwise, taxes will go up in 2026 and Social Security benefits will go down in a decade. Maybe the election will not affect the timing of your retirement, but it would be wise to keep an eye on where the election takes us. Who ends up in the White House and Congress could eventually affect your overall retirement income.