Retirees' finances are likely in for a much better year in 2023 than they just had in 2022. That's because inflation soared in 2022, resulting in elevated prices in pretty much all walks of life.
But in 2023, retirees' Social Security checks are set to rise by the largest amount in roughly four decades. That's because of the Social Security Administration's (SSA) cost-of-living-adjustment (COLA), which is intended to help preserve as much purchasing power for retirees as possible.
The bump will be welcome for the 66 million retirees who collect Social Security because recipients of the program are said to have lost as much as 40% of their purchasing power since 2000, according to a study from the non-partisan Senior Citizens League. But it is also going to come with a potentially expensive surprise.
Understanding the COLA
The way the SSA calculates the COLA is by looking at inflation data in the third quarter of the year based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This index tracks the prices paid by urban wage earners and clerical workers for a market basket of consumer goods and services.
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The SSA first calculates the average CPI-W number during the months of July, August, and September. Then it compares it to the prior year's numbers; the percentage difference represents the COLA for the following year.
For 2023, the COLA is 8.7%, a staggering number that shows just how intense inflation was. With the average Social Security check for retirees in November at about $1,632 per month, a typical recipient could see checks rise by about $142 in 2023, or more than $1,700 annually.
So, what's this expensive surprise?
Social Security benefits can be subject to taxation. Now, this typically only happens if you have supplemental income in addition to your benefits, which might be more relevant for filers claiming benefits early and still working. But it could also come into play for many other retirees because income from stocks such as dividends also counts.
The number that individuals need to look at is called combined income, which includes adjusted gross income plus nontaxable interest plus half of your Social Security benefits. If you are an individual and your combined income is more than $25,000, then 50% of your Social Security benefits could be taxed. To be clear, this isn't the tax rate; it's just the amount of your benefits potentially subject to taxation. If your combined income exceeds $34,000, then 85% of your Social Security benefits could be subject to taxation.
There are also thresholds for married couples. If the combined income of you and your spouse is over $32,000, then the two of you will be subject to taxation on 50% of your benefits. If your combined income is more than $44,000, then 85% of benefits are potentially subject to taxation.
With benefits set to rise by so much in 2023, the combined income of individuals and couples previously not subject to taxation may be pushed over the thresholds that trigger getting taxed. It's something to consider and look into as soon as possible because it could turn into an expensive surprise.
