The Social Security Administration announced a cost-of-living adjustment for Social Security benefits of 8.7% in 2023. Retirees can expect to see an increase in their monthly checks that reflects this change. While Social Security payments are adjusted for inflation, the income thresholds for taxing benefits remain the same. For some retirees, this could mean that more of their monthly income is taxed.
To see how your Social Security tax bill could be affected, it can be helpful to look at:
— How the COLA works.
— Taxes on Social Security benefits.
— Thresholds for paying taxes on benefits.
— How to plan for taxes.
How the Social Security COLA Works
The COLA serves to protect Social Security benefits from the eroding effect of inflation. “Each year, the Social Security Administration reviews the Consumer Price Index by comparing the third quarter results to the prior year third quarter,” says Drew Parker, founder of The Complete Retirement Planner, based in the Seattle area. The result determines the COLA for the following year. The COLA of 8.7% in 2023 is the largest increase for Social Security benefits in 40 years.
The larger Social Security payments will help retirees cover their regular expenses during the coming year. “By itself, this is good news for those who are claiming Social Security, or who will be age 62 by the end of the year,” Parker says. In 2022, the average benefit was $1,681. With the COLA, that amount will go up to $1,827 in 2023. This means that, on average, retirees could see their benefit rise by $146 a month.
[READ: Why Seniors Are Getting a Large Social Security COLA in 2023.]
Taxes on Social Security Benefits
If your income reaches or exceeds a certain threshold, the amount is taxable. “Those thresholds are not changing, despite the increase in benefits,” Parker says. The tax table for Social Security benefits went into effect in 1984, at which time it was determined that up to 50% of the benefit could be taxable. The rate was raised to 85% in 1993 and hasn’t changed since.
When the tax was first implemented, fewer than 10% of those receiving Social Security payments had their benefits taxed. By 2015, over half of families receiving Social Security payments paid taxes related to their benefit. With the COLA of 8.7%, tax bills could be impacted. “Social Security recipients are going to lose a portion of their increase to taxes, and some will be paying taxes on their benefits for the first time,” says Rob Burnette, CEO and financial advisor at Outlook Financial Center in Troy, Ohio.
[See: 10 Social Security Rules Everyone Should Know.]
Thresholds for Paying Taxes on Social Security Benefits
Social Security benefits undergo a formula to determine if taxes will be applied. It is calculated by taking 50% of your Social Security payment and adding the following:
— Earned income such as wages, salary or tips.
— Taxable interest.
— Dividends.
— Pensions and annuities.
— Any other income.
— Nontaxable interest.
The sum is then compared to the amounts listed on the tax table for Social Security. Couples who are married filing jointly and have a total of $32,000 or less will not pay taxes on their Social Security benefit. If they make between $32,000 and $44,000, up to 50% of the benefit can be taxed. For an amount that is over $44,000, up to 85% of the Social Security benefit is taxable.
For individuals who file as single, any amount up to $25,000 will not be taxed. For a sum that is between $25,000 and $34,000, up to 50% of the benefit can be taxable. For income totals that are above $34,000, 85% of the Social Security benefit could be taxable.
If you haven’t paid taxes before on Social Security income, you may now have to as a result of the 8.7% COLA. “Those who are significantly dependent on those benefits will actually be financially hurt by this lack of adjustment to the formula,” says Andrew Griffith, associate professor of accounting at Iona University.
[Read: How to Minimize Social Security Taxes.]
How to Plan for Social Security Taxes
If you receive Social Security benefits, you can look at what you paid in taxes during previous years to have a starting point. “The key to knowing how much, if any, of your Social Security benefit will be taxed is to keep track of your combined income for the year,” Parker says. You can set aside an amount to prepare for the upcoming tax bill.
There are additional ways to plan for taxes when receiving benefits. “To help reduce the sting when you file your income tax return, Social Security allows withholding from your benefit, and will report that withholding on Form SSA-1099 for each tax year,” Burnette says. You can file a Form W-4V to ask to have federal income tax taken out of your Social Security benefits.
Some states tax Social Security benefits, so you’ll want to check if your income will be taxable based on your location. Twelve states tax at least some of the Social Security benefits that residents receive. These include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia.
If you receive a certain amount of tax free interest and retirement income, such as Roth withdrawals and state and local government bonds, you could be subject to the alternative minimum tax. “AMT essentially says that, while you followed the main federal income tax system’s rules and legally minimized your federal income tax obligations, you still have to pay income taxes because you have too much tax-free income in your current tax year,” Griffith says. “Tax-free income causes Social Security recipients to have to pay more taxes on their Social Security benefits.”
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How 2023’s Social Security COLA May Raise Retiree Tax Bills originally appeared on usnews.com
