In October, seniors on Social Security got some seemingly good news. They learned that their benefits would be subject to an 8.7% cost-of-living adjustment (COLA) in 2023. That's the largest raise to come down the pike in decades.
But is an 8.7% COLA really something to celebrate? Here are two reasons it may not be.
1. Seniors might still lose buying power
The Social Security Administration doesn't give out raises at random, nor does it do so for no reason. Rather, Social Security COLAs are specifically pegged to inflation. And the reason benefits are going up by 8.7% in 2023 is that recent data from the Consumer Price Index for Urban Wage Earners and Clerical Workers showed a high enough annual increase in inflation levels to warrant a raise that high.
But since Social Security COLAs are tied to inflation, they don't necessarily give recipients added buying power. And when those raises fall short, seniors on Social Security lose buying power.
That's exactly what happened in 2022. Social Security benefits got a 5.9% COLA to start off the year, but then inflation rose at a faster clip. Now we don't know what inflation will be in 2023, and in recent months, it's been slowing. But if inflation levels largely hold steady in the coming year, an 8.7% raise may not help seniors all that much.
2. More seniors might get taxed on Social Security
Many people are shocked to learn that Social Security benefits can be taxable in retirement -- both at the federal and state level. Now to avoid the latter, all you really need to do is not settle down in a state that taxes Social Security. But the former can be hard to avoid.
The thresholds at which federal taxes on Social Security set in are pretty low. And Social Security payments themselves are factored into the formula used to determine whether taxes on benefits apply. So all told, a higher monthly benefit could bump more seniors over the threshold where taxes start to come into play.
Let's not celebrate just yet
It's easy to see why so many seniors may be thrilled with an 8.7% Social Security COLA in 2023. But it's also important to remember that a raise that large isn't guaranteed to have a positive financial impact on beneficiaries. And in some cases, it could even put certain seniors in a worse financial position by opening them up to taxes.
Of course, it's also easy to argue that a larger Social Security COLA in 2023 is preferable to a smaller one. And that's usually the case when it comes to earning money in general.
Higher wages tend to bump earners in to a higher tax bracket. That's just how our tax system works, and generally, it makes more sense to earn more money and pay more taxes than take a hit on wages and pay the IRS less tax.
But still, it's important for seniors to be realistic about their upcoming COLA. And it's also important that they recognize how a higher monthly benefit could have negative tax consequences.