Inflation is a huge concern for most folks at the moment. And with good reason, as prices on goods and services continue to rise at a steady clip.
Further exacerbating this situation is the fact that wages have failed to keep pace with the rising cost of living for several decades now.
The situation, however, is even more dire for retirees. But not in the way you might think.
Taxes on Social Security Benefits
Social Security benefits are adjusted for cost of living increases every year. And in 2023, benefits were hiked by 8.7%, the largest increase in over 40 years.
You might think this is good news, especially in light of soaring inflation. But there’s a catch.
You could owe income taxes on your social security benefits if your combined annual income (including benefits, pensions, retirement fund distributions, and other investment income) rises above a certain level.
So, while increased benefits in light of rising inflation, more and more retirees are seeing their taxes jump up on their Social Security benefits.
Why Social Security Benefit Taxes Are Rising
Individual retirees with provisional income over $25,000 and joint filers over $32,000 are hit with income taxes on up to 50% of their Social Security benefits.
And individual retirees with provisional income over $34,000 and joint filers over $44,000 can expect to have up to 85% of their Social Security benefits taxed.
The rub here is that while benefits are adjusted annually for cost of living increases, the threshold triggering taxes on benefits hasn’t been increased since 1984.
How Provisional Income is Determined
For retirees, your provisional income is calculated by adding up your gross income, tax-free interest from bonds and other income sources, and 50% of your Social Security benefits.
By way of example, let’s say your annual income is $50,000, and you receive $1,500 monthly for Social Security. Based on these figures, you must pay taxes on 85% of your $18,000 yearly benefits, which comes to $15,300.
The Solution
With significant cost of living adjustments to counter inflation in recent years, far more seniors are now subject to the 85% tax.
Yet, if thresholds had been adjusted alongside inflation, the $25,000 threshold set in 1984 would be roughly $70,000. And the $32,000 threshold for couples would be about $90,000.
Increasing these thresholds is the obvious correction, but US lawmakers have yet failed to address the issue. This appears to be mainly because neither constituents who qualify as “Seniors” nor advocates for senior rights have been tapped to join commissions or asked to participate in legislative or policy-related government negotiations.
Meanwhile, in the short term, you only have a few options to reduce taxes on your Social Security income. You could scale back your provisional income, taking less optional income. But this only works if you can cover your bills and finance your lifestyle with less money.
You could also convert your 401(k) or traditional IRA to a Roth IRA. Distributions from Roth IRAs don’t count as provisional income, though you will still have to pay taxes on the conversion.
Have Questions on Your Social Security Taxes?
Making do on a fixed income during your retirement years is already a tricky proposition. But adding rising tax liabilities on top is like an insult to injury.
If you have questions about managing your taxes in retirement — Get in touch for a FREE consultation!
