Social Security recipients may not benefit as much as expected from their 8.7% raise — and this outdated rule is to blame

Last October, seniors on Social Security learned that they would receive a cost of living adjustment (COLA) of 8.7%. And many breathed a sigh of relief.

Many seniors have been battling inflation in 2022, and last year’s 5.9% COLA hasn’t been able to keep up enough. This year, however, things look different, as the inflation rate has already fallen well below 8.7%. If the downward trend continues, seniors on Social Security could actually gain purchasing power for the first time in years.

That said, 2023’s bountiful COLA might not go as far as seniors expect. In fact, Social Security recipients could end up losing money this year — and it’s all because of a longstanding rule that is in serious need of an update.

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Will higher monthly benefits create a tax liability for you?

Older people do not automatically pay taxes on their social security benefits. Whether you’re required to do this will depend on your provisional income, which is essentially 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 tax on benefits are very low. And the reason is that they were created decades ago when the cost of living was much lower.

Currently, you will have to pay up to 50% of your Social Security benefits if your provisional income is between $25,000 and $34,000 and you are a single filer. Above $34,000, you could be taxed 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 kick in once your provisional income falls between $32,000 and $44,000. Above $44,000, up to 85% of your benefits could be taxed.

To be clear, in this context, we are talking about federal taxes. Some states also impose taxes on Social Security earnings.

Still, $25,000 is hardly a lot of money for a single person trying to maintain a decent standard of living in retirement (even though that figure applies to temporary income, not total income). And $32,000 isn’t much for a married couple either. Still, these are the provisional income figures used to dictate whether benefits are taxed or not, and lawmakers don’t seem keen on changing them.

Meanwhile, many seniors this year are likely to see their monthly benefits increase significantly due to a generous COLA. But unfortunately, this could push some people beyond the threshold to avoid federal Social Security taxes. In exchange for a higher monthly benefit, some seniors could lose out financially due to having to pay taxes they were once able to avoid.

Don’t be caught off guard

Many seniors are shocked to learn that Social Security income may be taxable in retirement. Now that you know what the thresholds look like, you can try taking steps to avoid paying taxes on your benefits, perhaps by adjusting the withdrawals you make from your savings.

Of course, in some cases, you may be required to pay taxes on your Social Security benefits due to the fact that you must withdraw the required minimum distributions from your retirement plan. But either way, it’s critical that you understand when and how Social Security taxes come into play so you can try to avoid them or fit them into your budget.

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