Next year, retirees will likely receive one of the largest cost-of-living adjustments (COLAs) in history.
While the official COLA for 2023 won't be announced until October, experts at The Senior Citizens League expect it will be around 8.7%. That's far higher than the usual 1% to 3% raise seniors receive most years, and it's also significantly larger than this year's whopping 5.9% COLA.
The good news is that a bigger benefit amount can go a long way toward fighting inflation and making retirement more affordable. The bad news, though, is that it could also increase your taxes in 2023.
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How much will you owe in taxes in retirement?
Even in retirement, you're subject to income taxes. State taxes will depend on where you live, and fortunately, 38 states do not tax Social Security.
Your federal taxes, though, will depend on a figure called your provisional income. This number is your adjusted gross income, any nontaxable interest, plus half of your annual Social Security benefit amount.
So, for instance, if you're withdrawing $30,000 per year from your 401(k) and are receiving $20,000 per year from Social Security, your provisional income would be $40,000.
Here's how much of your benefits could be subject to federal income taxes depending on your provisional income.
| Percentage of Your Benefits Subject to Federal Taxes | Provisional Income for Individuals | Provisional Income for Married Couples Filing Taxes Jointly |
|---|---|---|
| 0% | Less than $25,000 per year | Less than $32,000 per year |
| Up to 50% | $25,000 to $34,000 per year | $32,000 to $44,000 per year |
| Up to 85% | More than $34,000 per year | More than $44,000 per year |
Data source: Social Security Administration.
How the COLA will affect your taxes
Next year's COLA will likely be historic. If it does land around the estimated 8.7% figure, that will make it the largest increase in benefits since 1981.
It will also amount to an extra $144 per month for the average retiree. That's approximately $1,728 in additional income per year, which could potentially push you into a higher Social Security tax bracket.
For many retirees, this difference in taxes will be marginal. After all, only half of your annual benefit amount is included in your provisional income, and even in the highest tax bracket, only 85% of your benefits are subject to federal income taxes.
However, with inflation soaring, many older adults are already feeling the pinch. While the higher COLA can be helpful in covering these costs, paying even slightly more in taxes can make it more challenging for some seniors to make ends meet.
What you can do to prepare
You may not be able to avoid taxes on your benefits altogether. But understanding how they're calculated and how an increase in benefits could affect your tax situation is still helpful.
Perhaps the best thing you can do right now is to head into 2023 with realistic expectations. While next year's COLA will be one of the largest in history, it won't necessarily increase your disposable income. Between surging inflation and a potentially higher tax bill, that money may not go as far as it seems.
Still, a higher COLA will provide much-needed relief for millions of seniors. And when you have a big-picture view of how that adjustment will affect your entire financial situation, it will be easier to make the most of your benefits.
