How the Income Tax Treatment of Saving and Social Security Benefits May Affect Boomers' Retirement Incomes
Provisions of the federal income tax system affect both the buildup of retirement assets during workers’ careers and their after-tax income following retirement. Traditionally, Social Security benefits, tax-favored defined benefit plans and retirement saving accounts, and savings accumulated outside of tax-favored accounts have been viewed as the “three-legged stool” of retirement income sources. Income taxes affect all three sources of retirement income. As policymakers confront future shortfalls in Social Security financing, they could consider income tax changes to modify the effects of proposals that improve trust fund balances through benefit reductions or payroll tax increases. In so doing, it is important they recognize that different options will have substantially different effects on the income distribution of future retirees. nThis paper uses the Urban Institute’s Dynamic Simulation of Income Model (DYNASIM3) to simulate how potential changes in the tax treatment of retirement savings, Social Security benefits, and income from assets outside of retirement saving plans may affect boomers’ retirement incomes. Results show that changes in the income thresholds for taxing Social Security benefits have the largest impact on middle-income boomers, while changes in the contribution limits for retirement saving plans and tax rates on capital gains and dividends have the largest impact on the highest income boomers. Before enacting proposals that reduce retirement incomes of low- and middle-income retirees, policymakers could consider changing income tax rules that benefit the more affluent future retirees.