What the 8.7% Social Security COLA for 2023 Means for Taxes on Benefits

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Retirees who rely on Social Security benefits for income will get some relief from record-high inflation when the 8.7% cost-of-living adjustment kicks in next year.

But two factors — the size of Medicare Part B premiums and taxes on benefits — could offset how big those monthly checks will be in 2023.

The good news is that the standard monthly premium for Medicare Part B, which covers outpatient and inpatient coverage, will drop 3% next year to $164.90, from the current $170.10. Because these premiums are typically deducted directly from benefit checks, the lower rate will allow more beneficiaries to see a hit from the cost-of-living adjustment, or COLA.

More than Year-End Planning

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However, a higher COLA may push some beneficiaries into a higher tax bracket.

According to Brian Vosberg, president of Vosberg Wealth in Glendora, Calif., a certified financial planner and enrolled agent, the record COLA is “tremendous” for retirees as they struggle with higher prices on everything from rent to food.

“Even though they’re excited to see the increase come, they don’t really imagine what the impact could be from a tax standpoint, and then from a tax standpoint, it trickles down to their other expenses when they retire,” Vosberg said.

How Social Security benefits are taxed

Social Security benefits are taxed based on a formula known as “combined” or “temporary” income.

It’s calculated by taking your adjusted gross income and adding tax-free interest and half of your Social Security benefits.

Taxes on Social Security benefits apply to single taxpayers with a combined income starting at $25,000 and to married taxpayers starting at a combined income of $32,000.

Individuals with joint incomes between $25,000 and $34,000 pay up to 50% of their benefits in tax. The same is true for married couples earning between $32,000 and $44,000.

Up to 85% of Social Security benefits are taxable for individuals with a combined income of more than $34,000 and for couples with a combined income of more than $44,000.

According to the Center for Retirement Studies at Boston College, because the thresholds are not adjusted for wage growth or inflation, over time it has prompted more Social Security beneficiaries to pay taxes on their benefits.

When benefits taxes were first introduced in 1983, only 8% of eligible families paid benefits taxes. According to the Center for Retirement Research, that has risen to about 56% in 2021. At average inflation, this was projected to rise to 58% in 2030.

“If inflation rises faster, Social Security benefits will be higher in nominal dollars, and more families will pay more benefits — further reducing the net benefit,” write Alicia Munnell, director of the Center for Retirement Studies, and research associate Patrick Hubbard.

How Beneficiaries’ Taxes Could Increase in 2023

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According to Joe Elsasser, founder and president of CFP and Social Security claim software provider Covisum, an increase in Social Security income next year may not allow beneficiaries to increase their retirement savings without facing tax consequences.

For example, with an increase in tax brackets of about 7%, beneficiaries can withdraw 7% more from their individual retirement accounts next year and think they can have the same tax consequences.

“It’s not, because more Social Security is taxable,” Elsasser said.

However, according to Elsasser, there may be room for some beneficiaries to increase their pension money, which is still tax-free on their benefits.

For example, a married couple who are both over 65 and have $35,000 in Social Security benefits this year could withdraw $23,967 in 2022 and pay no federal income tax, Elsasser estimates.

Don’t wait until April 15th to see your CPA; it’s too late.

Brian Vosberg

President of Vosberg Wealth

In 2023, this couple’s Social Security benefit would increase to $38,045 with COLA, and the amount they would withdraw could be as high as $24,793, Elsasser said.

If the couple’s Social Security benefits were $60,000 instead, then they could take out $65,220 in benefits in 2023 and a slightly lower $18,585 tax-free deduction of $18,703.

To be sure, results will vary based on an individual’s or couple’s unique financial situation.

Beneficiaries who have a choice of where to take their supplemental income should reevaluate that choice each year to get the best tax results, Elsasser said.

What to do to minimize the tax bite

The goal, experts say, is to determine a mix of retirement income that works for your personal situation and keeps your total or combined income within certain limits.

If you have money saved in both retirement and other accounts, you can use tax software and change the amount of your IRA withdrawal, Elsasser said.

“But this is definitely the domain of tax-driven financial planners,” Elsasser said.

Whatever your budget, you should be gunning to figure out where that income is going to come from by January 1, according to Vosberg.

“Don’t wait until April 15th to see your CPA; it’s too late,” Vosberg said. “The income you already have is almost set in stone.”

Beneficiaries who continue with the status quo on retirement and bank interest may end up paying more tax at the end of next year if they are inactive, he said.

To minimize your tax burden, try to withdraw money from tax-free income sources such as Roth individual retirement accounts, Vosberg said.

As the Federal Reserve’s interest rate hikes take effect, he said, it’s also wise to pay attention to how much interest you’re putting into savings that can boost your income, including money market accounts and certificates of deposit.

Having a higher income than the Social Security COLA can also affect how much you pay for health insurance, Vosberg said.

Those under 65 who are covered by the Affordable Care Act may see their subsidies or premium credits reduced. Those on Medicare may have higher copayments for Medicare Parts B and D.

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