There have been rumors that Social Security retirees may pay higher taxes in 2023 and 2024 due to inflation.
but what does that mean exactly?
First: you don’t have to worry about it if Social Security is your only source of income.
But if you’re about to have to pay taxes on your Social Security benefits, recent and upcoming cost-of-living adjustments may push you over the edge.
Here’s what you need to know.
How are social security benefits taxed?
Not everyone is taxed on their Social Security advantages.
The amount of tax you may owe depends on the other income you receive this year.
To determine if you owe taxes, the Social Security Administration takes into account what is called your “combined income.”
Here’s how it works.
When you pay social security taxes
Retirees must pay taxes on their Social Security benefits if:
- Half of their annual Social Security benefits + other income = more than $25,000 for single filers or $32,000 for married couples filing jointly.
The IRS will not tax all of your Social Security income, even if you exceed these thresholds. In place:
50% of your social security benefits are taxable if:
- Half of your benefits + other income = $25,000 to $34,000 for individuals Where $32,000 to $44,000 for married couples filing jointly.
85% of your social security benefits are taxable if:
- Half of your benefits + other income = $34,000 and more for individuals Where $44,000 or more for married couples filing jointly
According to Social Security Administration.
When you don’t pay social security taxes
If Social Security is your only source of retirement income, your benefits will most likely not be taxed.
It is because the average monthly benefit the amount is $1,623, or $19,476 per year in 2022, according to the Social Security Administration.
This is well below the $25,000 limit for single filers.
And remember, Social Security only includes half your benefits when determining your combined income.
Why some retirees might pay more taxes in 2023 and 2024
This is thanks to the annual cost of living adjustment (COLA) of social security, which was a record 5.9% this year — increase the average payment by $92 per month.
Recently, the Senior Citizens League, a nonpartisan advocacy group in Washington D.C., estimated COLA could be around 10.5% in 2023, which is another monthly benefit increase of $175.10 on average. or $2,101 per year.
Both of these increases could push retirees who once went tax-free above the $25,000 threshold for single filers or $32,000 for married couples filing jointly.
“Unlike income brackets, these thresholds have never been adjusted for inflation,” said Mary Johnson, an analyst at The Senior League. “More Social Security recipients are paying tax on a portion of their benefits as incomes rise over time.”
What could a 10.5% cost of living adjustment mean for your taxes?
Curious how a possible 10.5% Social Security COLA might impact your taxes?
Here is an example.
Suppose Bob receives $1,700 per month in 2022 from Social Security or $20,400 per year.
Bob also earned $10,000 from a part-time job and withdrew $4,000 from his traditional 401(k).
In this example:
- Half of Bob’s social security benefits = $10,200
- Her other income = $14,000
- Bob’s combined income is $24,200 in 2022, which means his Social Security benefits are not taxable when he files his taxes in 2023.
However, if a potential COLA of 10.5% comes into effect next year…
In 2023, Bob’s Social Security payment increases by $178.50 per month, bringing his annual Social Security benefit from $2,142 to $22,542.
Bob earns the same amount from a part-time job in 2023 ($10,000) and withdraws the same amount from his traditional 401(k) ($4,000).
In this example:
- Half of Bob’s social security benefits = $11,271
- Her other income = $14,000
- Bob’s combined income is $25,271 in 2023, which means 50% of his Social Security benefits are taxable in 2024 when he files his taxes.
The Social Security Administration sends out COLA notices by mail, but you can check your online account and activate notifications to be informed of any new message.
What to Keep in Mind About Social Security, Inflation, and Taxes
The cost of living adjustment for next year will not be announced until October. The projected benefit increase of 10.5% is an estimate by the Senior League and is based on rising inflation.
Also, while 50% or 85% of your Social Security benefits may be taxable, they will be taxed at the rate of your ordinary income.
Here is a table of Tax brackets 2021-2022 for reference. (Ordinary tax rates for next year have yet to be announced).
The Social Security Trust Fund is estimated to receive more than $45 billion in tax benefits in 2022 – a 30.4% increase from 2021, when it raised about $34.5 billion, according to a program administrators report.
This is how the 2021 annual report of the Board of Social Security describes it: “The income thresholds used for the taxation of benefits are specified in the tax code as being constant in the future and not have never been changed, while income and benefit levels continue to rise. As a result, the projected ratios of income from the taxation of benefits to the amount of benefits gradually increase.
The COLA increase could have a bigger impact on married couples, especially if one person is still working and earning a salary.
This is because even if your spouse received no benefits this year, you must add your spouse’s income to yours to determine whether any of your Social Security benefits are taxable, according to the Internal Revenue Service.
Rachel Christian is a Certified Personal Finance Educator and Senior Writer for The Penny Hoarder.