- Inflation has pushed Social Security's annual increases up to historic highs for the past couple of years.
- That may trigger a bigger tax bill for some beneficiaries. But proper planning can help.
Social Security recipients are just starting to see the record 8.7% cost-of-living adjustment in their monthly checks.
But come tax time, they could see surprises resulting from last year's 5.9% increase, which at the time was the biggest COLA in four decades.
Last year's 5.9% cost-of-living adjustment was like getting a 6% wage bump in 2022, according to Mary Johnson, Social Security and Medicare policy analyst at The Senior Citizens League. Yet that boost to benefits was not enough to keep up with rising costs, according to recent research from the nonpartisan senior group.
A recent survey by The Senior Citizens League found 57% of older taxpayers worry more of their Social Security benefits will be taxed due to last year's 5.9% cost-of-living adjustment. The survey, which was conducted last summer, included about 1,500 participants.
"There are a tremendous amount of people who are concerned," Johnson said.
More Social Security beneficiaries may be required 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 do file, the higher benefit income may be partly offset by a larger standard deduction and indexing of the tax brackets, he said.
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The new 8.7% cost-of-living adjustment that went into effect this month may make tax planning more complicated for more than 65 million beneficiaries who rely on Social Security checks.
From a tax savings perspective, there is not much you can do to mitigate your liability for this tax filing season, according to Brian Vosberg, a certified financial planner and enrolled agent who is president of Vosberg Wealth in Glendora, California.
"Once it's Dec. 31, there's very little you can do to actually minimize your tax liability," Vosberg said.
One 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 get a jump on their tax planning for next year to mitigate the effects of the 8.7% cost-of-living adjustment.
Social Security benefits are taxed based on a formula called combined income.
"The max Social Security that can be included in taxable income is 85%," Vosberg said. "So you always will get 15% of your benefit non-taxable."
Combined income includes your adjusted gross income, nontaxable interest and half of your Social Security benefits. Income including interest, dividends, capital gains and distributions from 401(k)s or IRAs are all added into that equation, Vosberg said.
Up to 50% of benefits are taxed for individual tax filers with between $25,000 and $34,000 in combined income and those who are married and filing jointly with between $32,000 and $44,000 in combined income.
Up to 85% of benefits may be taxable for individuals with more than $34,000 in combined income or married couples with over $44,000.
Because those thresholds are not adjusted for inflation, more beneficiaries may be subject to taxes on their benefits.
As interest rates rise, you may also be earning higher interest payments on your cash, which could also push up your combined income, Vosberg said.
One caveat for 2023 is the IRS has put in place higher federal tax brackets to adjust for inflation.
For beneficiaries, now is a good time to plan their 2023 income to ensure the most tax efficient blend of income, Vosberg said.
For example, if you're budgeting for $5,000 in income per month, and your monthly Social Security checks are $2,000, you may look to withdraw money you've already paid tax on for the remaining $3,000. That may include traditional savings or Roth IRAs.
"You blend the income and you can effectively control your taxes in retirement," Vosberg said.
"A lot of times [that can] reduce the tax that you're paying or even eliminate the tax that you're paying on Social Security," he said.
To accomplish that, it is important to loop in a qualified tax planner or CPA, Vosberg said.
Pre-retirees can also benefit from professional guidance. By building up their post-tax money through savings or Roth conversions in the years leading up to retirement, they may more effectively control their taxable income later on, Vosberg said.