More than 50 million Americans currently receive Social Security retirement benefits, and nearly nine in 10 retired workers say those monthly checks are an important source of income, according to a poll from Gallup. Unfortunately, many of those people have seen their financial well-being deteriorate over the past year as inflation has rippled through the U.S. economy.
Tumbling stock prices have erased $1.4 trillion from 401(k) plans, while wiping away another $2 trillion from individual retirement accounts, or IRAs. Meanwhile, Medicare Part B premiums jumped 14.5%, marking the second-largest price hike in the last decade, and the rising cost of food, fuel, and home utilities cut deeply into Social Security benefits.
Not surprisingly, many beneficiaries are looking forward to a massive cost-of-living adjustment (COLA) next year. And given the trajectory inflation has followed, Social Security's COLA in 2023 could be as high as 9%, according to Marc Goldwein of the Committee for a Responsible Federal Budget. That would be the largest increase in benefits since 1981 on a percentage basis, and the largest increase in history in terms of nominal dollars. But a historic COLA brings both good and bad news for retirees.
The good news: A big Social Security COLA will help seniors battle inflation
Social Security COLAs are based on inflation data from the third quarter of each year, which runs from July through September. There are many ways to measure inflation, but the metric used for this calculation is the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). For example, the CPI-W increased 5.9% in the third quarter of 2021, so a COLA of 5.9% was applied to Social Security benefits in 2022.
Those annual adjustments are intended to protect the buying power of benefits, but something unfortunate happened over the past year. Inflation continued to accelerate after the third quarter of 2021. In fact, the CPI-W has climbed at a higher rate than 5.9% in each month since then. That means the 5.9% COLA applied to benefits this year was not enough to cover the cost of rising prices. In fact, according to The Senior Citizens League, the average benefit was short by $417.60 through August.
From that perspective, a 9% COLA in 2023 would be great news for retirees. The average benefit paid to retired workers would rise by about $150 per month, and that extra cash would help repair the damage done by inflation this year, especially if inflation continues to cool as it has in the last two months.
As a caveat, the official Social Security COLA for 2023 cannot be calculated until the Bureau of Labor Statistics releases its September inflation report on Oct. 13, 2022. Retirees should expect an official figure that same day.
The bad news: A big Social Security COLA means more seniors will pay taxes on benefits
Unfortunately, there is a downside to the historic Social Security COLA. More retirees will have to pay taxes on their monthly benefit, especially those who have other sources of income. That problem has been gaining momentum for years, simply because the tax thresholds for Social Security benefits have never been adjusted for inflation.
Fewer than 10% of beneficiaries paid taxes on Social Security income in 1984, the year benefits were first subjected to taxation. But because the thresholds have never been adjusted, every COLA since then has pushed more seniors over the limit. Today, about half of beneficiaries pay taxes on their Social Security checks, according to the Congressional Research Service. A massive COLA in 2023 will only add fuel to that fire.
This calculator from the Internal Revenue Service (IRS) can help retired workers and their spouses determine whether any portion of their Social Security benefits is taxable. Retirees who owe taxes on benefits can either make quarterly estimated payments to the IRS, or they can elect to have federal taxes withheld from benefits throughout the year by completing a Form W-4V.
