Although Social Security has been around for many years, the program is constantly evolving. Next year, for example, some key changes are coming down the pike, including a substantial cost-of-living adjustment (COLA), a higher wage cap for Social Security tax purposes, and a higher earnings-test limit for those who work and collect benefits at the same time.
But there's one Social Security rule that hasn't changed in many years, and it has to do with the income thresholds at which taxes on benefits apply. And because that rule hasn't evolved, seniors today risk losing out on a chunk of their benefits -- benefits they might otherwise need to stay afloat.
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An age-old rule that desperately needs an update
Seniors whose sole income source is Social Security usually don't have to worry about their benefits getting taxed. But those with outside income often lose some of their benefits to taxes.
Whether that happens or not hinges on seniors' provisional income, which is calculated by taking their non-Social Security income plus half of their annual benefits. Taxes on up to 50% of benefits come into play at the following provisional-income thresholds:
- $25,000 to $34,000 for single tax-filers
- $32,000 to $44,000 for married couples filing jointly
Meanwhile, taxes on up to 85% of benefits come into play when single tax-filers have a provisional income above $34,000 and married couples who are joint filers have one above $44,000.
If these thresholds don't seem very high, it's because they aren't. And it's also because they were put into place decades ago, when the cost of living was substantially cheaper.
In 1983, the provisional-income limits above were put into place that resulted in taxes on up to 50% of benefits. Ten years later, the limits that established the higher 85% threshold were established. Meanwhile, these limits have not been revisited since 1993, which means seniors have been subject to a dated set of rules, despite continuously rising living costs.
What adds insult to injury is the fact that the Social Security Administration is very aware of the way increasing living costs can impact retirees. That's why COLAs are so important.
But since the average monthly Social Security benefit has increased substantially since 1993, you'd think that the thresholds for taxing benefits would have followed suit. For some odd reason, that just hasn't happened. And so now, seniors are stuck losing part of their benefits to taxes at income levels that barely set the stage for a comfortable retirement.
Preparing for taxes
Unless lawmakers decide to change the aforementioned rules, many seniors will continue to have their Social Security income taxed. And that's something that should be accounted for in the course of retirement planning.
One good way to lower the chances of having Social Security benefits taxed is to save for retirement in a Roth IRA. Roth IRA withdrawals aren't taxable and don't count toward provisional income, so that's one step savers can take to get around an otherwise outdated rule that desperately needs an update.
