Well, it's official. For months, experts have been talking about seniors on Social Security being in line for a massive raise in 2022. And this week, the Social Security Administration announced that beneficiaries will be getting a 5.9% cost-of-living adjustment (COLA), the largest to come down the pike in decades.
In comparison, seniors only saw a 1.3% COLA going into 2021. And so a 5.9% boost gives beneficiaries a lot more buying power.
But while a generous Social Security raise is a good thing in theory, there's one scenario where it could actually backfire. And seniors need to gear up for that possibility.
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Will a giant raise result in taxes on your benefits?
Seniors are often shocked to learn that Social Security income is, in fact, subject to taxes. But whether taxes apply to those benefits depends on how much income seniors have.
Taxes on Social Security hinge on provisional income, which is the sum of non-Social Security income plus 50% of one's annual benefit. For those who are single, a provisional income under $25,000 means Social Security won't be taxed.
But singles with a provisional income range of $25,000 to $34,000 risk taxes on up to 50% of their benefits. And those with a provisional income above $34,000 risk taxes on up to 85% of their benefits.
These thresholds are slightly higher for married couples collecting Social Security. In that case, couples with a provisional income under $32,000 get to keep their benefits in full.
But a provisional income of $32,000 to $44,000 means that up to 50% of benefits can be taxed. And beyond $44,000, up to 85% of benefits can be taxed.
Here's how next year's COLA comes into play. Seniors who are currently on the cusp of being taxed on Social Security could see their benefits rise to the point where their provisional income exceeds the above limits. The result? Being hit with taxes on benefits for the first time.
Avoiding taxes on Social Security
One of the most frustrating things about taxes on Social Security is that the income thresholds above haven't changed in decades, even though the cost of living has increased exponentially. And while current seniors may not be able to do much to lower their provisional income, future beneficiaries can take steps to avoid seeing their Social Security income taxed.
Perhaps the most efficient way to do so is to save for retirement in a Roth IRA. Roth IRA withdrawals aren't taxable and don't count toward provisional income. And given that Social Security itself doesn't pay all that generously -- the average senior today collects about $1,559 a month -- it's easier to avoid taxes on benefits when retirement plan withdrawals aren't a factor.
Given the way the cost of living has risen in recent months, it's imperative that seniors on Social Security be given a chance to keep up, and a 5.9% raise certainly helps achieve that goal. Just be aware that boosted benefits could result in a very unwanted tax surprise.
