This past October, seniors on Social Security learned that they'd be getting an 8.7% cost-of-living adjustment (COLA). And many breathed a sigh of relief.
Lots of seniors struggled with inflation in 2022, and last year's 5.9% COLA didn't do a good enough job of keeping pace with it. This year, things are shaping up to be different, though, because the rate of inflation has already dipped to well below 8.7%. If it continues to trend downward, seniors on Social Security might actually gain some buying power for the first time in years.
That said, 2023's generous COLA may not go as far as seniors expect. In fact, Social Security beneficiaries could end up losing money this year -- and it's all because of one long-standing rule that's in serious need of an update.
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Will higher monthly benefits create a tax liability for you?
Seniors don't automatically pay taxes on their Social Security benefits. Whether you're required to do so will hinge on your provisional income, which is basically your modified adjusted gross income plus half of your annual Social Security benefit.
The problem is that the provisional-income thresholds that can lead to taxes on benefits are very low. And the reason is that they were established decades ago, when living costs were much lower.
Right now, you'll face taxes on up to 50% of your Social Security benefits if your provisional income falls between $25,000 and $34,000 and you're a single tax filer. Beyond $34,000, you could face taxes on up to 85% of your benefits.
If you're married and filing a joint tax return with your spouse, taxes on Social Security benefits will come into play once your provisional income falls between $32,000 and $44,000. Beyond $44,000, up to 85% of your benefits could be taxed.
To be clear, in this context, we're talking about federal taxes. There are certain states that impose taxes on Social Security income, as well.
Still, $25,000 is hardly a lot of money for a single individual trying to maintain a decent standard of living in retirement (even if that figure applies to provisional income, not total income). And $32,000 isn't a lot for a married couple, either. Yet these are the provisional income figures used to dictate whether benefits are taxed or not, and lawmakers don't seem very eager to change them.
Meanwhile, this year, many seniors are apt to see their monthly benefits rise substantially due to a generous COLA. But unfortunately, that could push some people beyond the threshold of avoiding federal taxes on Social Security. In exchange for a higher monthly benefit, some seniors might lose out financially by virtue of having to pay taxes they were once able to steer clear of.
Don't get caught off guard
Many seniors are shocked to learn that Social Security income can be taxable in retirement. Now that you're aware of what the thresholds involved look like, you can try to take steps to avoid paying taxes on your benefits -- perhaps by adjusting the withdrawals you take from your savings.
Of course, in some cases, you may be forced to pay taxes on your Social Security benefits by virtue of having to take required minimum distributions from your retirement plan. But either way, it's essential that you understand when and how taxes on Social Security come into play so you can either try to avoid them or factor them into your budget.
