Inflation will raise Social Security payments. This boon could lead to a hefty tax burden. With inflation at 8.5% after reaching 9.1% this year, Social Security retirees should expect a COLA next year. Social Security payouts rose 5.9% after 2021’s 7% inflation. For someone receiving the average benefit, that’s a $96-a-month rise.
But inflation can also hurt.
At tax time, Social Security claimants who’ve raised their income to pay for petrol, food, rent, and more could be taxed 50% to 85% of their extra income.
Financial advisors can help you understand how a COLA increase may influence your retirement taxes.
Will Social Security Taxes Be High?
Someone earning $500 a week or withdrawing slightly more than $2,000 a month from a retirement account could find that 85% of their Social Security payments are taxable.
Since half of your Social Security benefits count toward income restrictions, your inflation-adjusted monthly check might push you over.
While many parts of the tax code automatically adjust for inflation, such as income levels for tax brackets, the income limits at which Social Security benefits become taxable are stuck at the same dollar amounts from the year they were created – 1983 for the tax on 50% of benefits and 1993 for the tax on 85% of benefits.
The SSA calculates “combined income” as follows:
AGI plus nontaxable bond interest plus half of Social Security
AGI includes salary, dividends, capital gains, company income, most pension income, and taxable retirement account distributions.
If you offset inflation by withdrawing more from a traditional IRA, 401(k), 403(b), or another taxable retirement account, or if you earn more from a job, that extra money can boost your combined income above the threshold for taxable benefits. Roth IRA withdrawals aren’t counted in AGI.
Social Security Income Limits
Social Security income restrictions are low and readily reached with payout increases.
Up to 50% of benefits may be taxed at $25,000 to $34,000.
Above $34,000, 85% of benefits may be taxed.
Up to 50% of benefits may be taxed at $32,000 to $44,000.
Above $44,000, 85% of benefits may be taxed.
How this affects each individual or couple depends on how much inflation-adjusted tax brackets cut federal taxes vs how much static Social Security income limitations raise combined income.
Social Security benefits weren’t taxed until Ronald Reagan approved the 1993 bill. In 1984, the income cap was $25,000 for single taxpayers and $32,000 for joint filers, with 50% of benefits taxed. The Omnibus Budget Reconciliation Act of 1993 added the 85% tax benefit rule, putting the cap at $34,000 for single filers and $44,000 for joint filers.
Since the benefits tax was last changed, no restrictions have been raised.
If they had, the 50% tax threshold for single filers would be $72,600 and for joint filers $93,000. Single filers’ 85% benefit tax limit would be $69,000 and joint filers’ $89,000.
In 1984, 10% of Social Security beneficiaries were projected to be taxed. Social Security Administration anticipates 56% of benefit recipients will repay income taxes in 2022.
With Social Security COLA rises amid rising inflation, retirees who withdraw more from retirement savings to keep up with inflation could face a substantial tax penalty. Consult a financial counselor about investments, withdrawals, and taxes.
Retirement Planning Tips
Unsure how a Social Security increase will affect you? Consult a financial counselor for a long-term financial plan and help reduce tax liability.
SmartAsset’s free service matches you with up to three local financial advisors. You can interview them for free to decide which one is best. Start looking for a financial counselor now. SmartAsset’s free retirement calculator can help you decide how much money to remove from your retirement funds.