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Social Security recipients are just beginning to see the record 8.7% cost-of-living adjustment in their monthly checks.
But come tax time, they could see surprises coming from last year’s 5.9% surge, which was then the biggest COLA in four decades.
According to Mary Johnson, Social Security and Medicare Policy Analyst at The Senior Citizens League, last year’s 5.9% cost-of-living adjustment was like a 6% wage increase in 2022. But that benefit increase wasn’t enough to keep pace with rising costs according to a recent study by the non-partisan senior citizens’ group.
A recent survey by the Senior Citizens League found that 57% of older taxpayers worry more will be taxed on their Social Security benefits due to the 5.9% cost-of-living adjustment over the past year. The poll, conducted last summer, included about 1,500 participants.
“There’s a tremendous amount of concern among people,” Johnson said.
More Social Security recipients may have to file tax returns this season, but that will likely be a “relatively small number,” predicts Paul Van de Water, a senior fellow at the Center on Budget and Policy Priorities.
For beneficiaries who apply, the higher benefit income may be partially offset by a larger standard deduction and tax bracket indexation, he said.
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The new 8.7% cost-of-living adjustment that went into effect this month could complicate tax planning for more than 65 million benefit recipients who rely on Social Security checks.
According to Brian Vosberg, a board-certified financial planner and registered agent who is president of Vosberg Wealth in Glendora, California, from a tax savings perspective, there’s not much you can do to mitigate your liability this tax filing season.
“Once it’s December 31, there’s very little you can do to actually minimize your tax liability,” Vosberg said.
An exception is if you make a prior-year contribution to an individual retirement account before April 15, which can help reduce your taxable income.
However, beneficiaries would be wise to boost their tax planning for next year to mitigate the impact of the 8.7% cost-of-living adjustment.
How social benefits are taxed
Social Security benefits are taxed based on a formula called combined income.
“The maximum Social Security that can be included in taxable income is 85%,” Vosberg said. “So you always get 15% of your performance tax-free.”
The combined income includes your adjusted gross income, tax-free interest, and half of your Social Security benefits. Income including interest, dividends, capital gains, and distributions from 401(k)s or IRAs are all factored into this equation, Vosberg said.
Up to 50% of benefits are taxed for single taxpayers with combined income between $25,000 and $34,000 and for married couples with combined income between $32,000 and $44,000.
Up to 85% of benefits may be taxable for individuals with combined incomes over $34,000 or over $44,000 for married couples.
Because these thresholds are not adjusted for inflation, more beneficiaries may be subject to taxes on their benefits.
If interest rates rise, you may also earn higher interest payments on your cash, which could also boost your combined income, Vosberg said.
One caveat for 2023 is that the IRS introduced higher federal tax brackets to adjust for inflation.
Tips for minimizing the tax burden
Now is a good time for beneficiaries to plan their income for 2023 to ensure the most tax-efficient income mix, Vosberg said.
For example, if you are budgeting for an income of $5,000 per month and your monthly Social Security checks are $2,000, you can attempt to withdraw money that you have already paid taxes on the remaining $3,000 on. These can include traditional savings deposits or Roth IRAs.
“You blend the income and you can manage your taxes effectively in retirement,” Vosberg said.
“Often [that can] reduce the taxes you pay or even eliminate the taxes you pay on Social Security,” he said.
In order to do this, it’s important to consult a qualified tax planner, or CPA, Vosberg said.
Early retirees can also benefit from professional advice. By building up their after-tax money through savings or Roth conversions in the years leading up to retirement, they can more effectively control their taxable income later, Vosberg said.
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