Social Security changes every year. This isn't because lawmakers take action to modify the entitlement program. Changes occur automatically due to the way it is designed.
However, while many modifications occur when a new year begins, there's one rule that stays the same. Unfortunately, this rule can end up costing seniors a lot of money.
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Most aspects of Social Security change to keep pace with inflation
The automatic changes that are built into the Social Security benefits program exist for a simple reason: To ensure that benefits don't see their value erode due to inflation.
Inflation naturally occurs over time. Prices of goods and services rise, and wages go up so people can still afford to cover their expenses. Most seniors don't work and don't get raises from employers, though. To protect their buying power, cost-of-living adjustments (COLAs) are built into Social Security. Because of COLAs, benefits increase in most years as long as a consumer price index shows costs are going up on a basket of goods and services.
In addition to a COLA that goes into effect in most years, other aspects of Social Security change automatically as well in order to make sure that inflation doesn't undermine effective operations. For example:
- Workers must make a little more money each year in order to earn work credits that entitle them to benefits on their own work history.
- The maximum income subject to Social Security tax on current workers goes up each year so higher earners pay a little more into the system (and get a larger benefit because of it).
- There's an increase in the amount retirees can earn before forfeiting some of their Social Security benefits when working and collecting checks simultaneously prior to full retirement age
These changes affect both current and future retirees and they happen like clockwork.
This rule hasn't changed for decades and won't anytime soon
Although Social Security recognizes and accounts for the impact of inflation in most aspects of the retirement benefits program, there is one rule that doesn't change and hasn't for decades. It has to do with when you owe taxes on Social Security benefits as a retiree.
See, once what the Social Security Administration calls your "combined income" hits $25,000 as a single tax filer or $32,000 as a joint tax filer, you start to owe taxes on some of your benefits. Combined income is half your Social Security checks, all taxable income, and some nontaxable income including municipal bond interest. If your combined income falls below these thresholds, there's no federal tax on Social Security. But if it's above it, the IRS could tax up to 85% of benefits, depending on just how high your earnings climb.
These thresholds were put in place decades ago and are not indexed to inflation. So, even though Social Security benefits are increasing by 8.7% next year due to the COLA for 2023, the amount you can earn before your benefits become taxable isn't changing. Since this earnings limit doesn't adjust even as people end up bringing home more money each year, a growing number of retirees are subject to tax. This is true even when their buying power isn't actually increasing, since their bigger payments are just designed to help them avoid losing ground as prices go up.
If you're on the cusp of having your benefits taxed in 2022, the Social Security cost-of-living adjustment (or increases to any other income source) could put you over the edge. So, be sure to plan for possible taxation of your benefits. And if this isn't something you're worried about this year, know that over time you could find yourself facing new taxes as your income naturally grows while the threshold for taxation of benefits remains unchanged.
