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 contribution bill could be affected, it may be useful to consult:
- How COLA works.
- Taxes on social security benefits.
- Benefit tax payment thresholds.
- How to plan your taxes.
How the Social Security COLA works
The COLA is used to protect social security benefits from the eroding effect of inflation. “Each year, the Social Security Administration reviews the Consumer Price Index by comparing third quarter results to the third quarter of the previous year,” says Drew Parker, founder of The Complete Retirement Planner, based in the Los Angeles area. Seattle. The result determines the COLA for the following year. The 8.7% COLA in 2023 is the largest increase in Social Security benefits in 40 years.
The larger Social Security payments will help retirees cover their regular expenses in the coming year. “That in itself is good news for anyone filing for Social Security or turning 62 by the end of the year,” Parker says. In 2022, the average benefit was $1,681. With the COLA, this amount will increase to $1,827 in 2023. This means that, on average, retirees could see their benefit increase by $146 per month.
Taxes on social security benefits
If your income reaches or exceeds a certain threshold, the amount is taxable. “These thresholds don’t change, despite the increase in benefits,” Parker says. The Social Security benefit tax table came into effect in 1984, when it was determined that up to 50% of the benefit could be taxed. The rate was increased to 85% in 1993 and has not changed since.
When the tax was first introduced, less than 10% of people receiving social security benefits had their benefits taxed. In 2015, more than half of families receiving Social Security benefits paid taxes related to their benefit. With a COLA of 8.7%, tax accounts could be impacted. “Social Security recipients will lose some of their raise in taxes, and some will pay tax on their benefits for the first time,” says Rob Burnette, CEO and financial adviser at Outlook Financial Center in Troy, Ohio.
Thresholds for paying taxes on social security benefits
Social Security benefits are subject to a formula to determine whether taxes will be applied. It is calculated by taking 50% of your Social Security payment and adding the following:
- Earned income such as wages, salaries or tips.
- Taxable interest.
- Pensions and annuities.
- Any other income.
- Non-taxable interest.
The sum is then compared to the amounts listed on the Social Security tax table. Married couples who file jointly and have a total of $32,000 or less will not pay taxes on their Social Security benefits. If they earn between $32,000 and $44,000, up to 50% of the benefit may be taxed. For an amount over $44,000, up to 85% of the Social Security benefit is taxable.
For individuals who claim to be single, any amount up to $25,000 will not be taxed. For an amount between $25,000 and $34,000, up to 50% of the benefit may be taxable. For total incomes over $34,000, 85% of Social Security benefits could be taxable.
If you have not previously paid taxes on Social Security income, you may now have to do so due to the 8.7% COLA. “Those who are significantly dependent on these benefits will actually be financially impacted by this lack of adjustment to the formula,” says Andrew Griffith, associate professor of accounting at Iona University.
How to plan social security contributions
If you’re collecting Social Security benefits, you can look up what you’ve paid in taxes in previous years to get 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,” says Parker. You can set aside an amount to prepare for the upcoming tax bill.
There are other ways to plan for taxes when you receive benefits. “To help reduce the sting when you file your taxes, Social Security allows withholding from your benefits and will report this withholding on Form SSA-1099 for each tax year,” Burnette says. You can file a Form W-4V to request that federal income tax be deducted from 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 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 non-taxable interest and retirement income, such as Roth withdrawals and state and local government bonds, you may be subject to alternative minimum tax. “The AMT basically says that even if you followed the main rules of the federal income tax system and legally minimized your federal tax liability, you still have to pay income taxes because you have too much non-taxable income in your current tax year,” says Griffith. . “Tax-exempt income forces Social Security recipients to pay more taxes on their Social Security benefits.”