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Retirement Planning > Social Security

More Retirees to Face Taxes on Their Social Security Benefits This Year

By John Manganaro

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What You Need to Know

  • The sizable Social Security COLAs for 2022 and 2023 could push more people above the income level at which benefit taxes kick in.
  • Beneficiaries can owe taxes on up to 85% of their Social Security benefits when combined income exceeds $25,000 for single filers or $32,000 for couples.
  • These income thresholds aren’t adjusted for inflation, leading some advocacy groups to call for reform.

About half of older households are subject to the tax on Social Security benefits, but that number could increase rapidly in the years ahead thanks to the effects of recent cost-of-living adjustments (COLAs) and growing income from pensions, savings and other sources.

According to Mary Johnson, Social Security and Medicare policy analyst at The Senior Citizens League, this year’s near-record COLA of 8.7% is a boon to many retirees facing financial hardships in the face of rapid inflation and greater longevity. However, the raise will also likely drive many Americans over the income thresholds at which benefits begin to be taxed.

During a recent interview with ThinkAdvisor, Johnson projected that the 2024 COLA could fall well below 3%, and depending on what happens with the inflation rate through the third quarter, there is a decent chance that no COLA could be granted to beneficiaries next year.

During the interview, Johnson also took time to discuss the results of a new poll conducted by her organization, which shows that more than half (51%) of survey respondents worry they will pay more in taxes this tax season because of recent COLAs. This includes one in five who worry they may be subject to a tax on their Social Security benefits for the first time this tax season.

“The worries will continue next year due to the significant 8.7% COLA this year,” Johnson says.

A Need for Adjustments?

According to The Senior Citizens League poll, about 58% of survey participants think the income thresholds that subject Social Security benefits to taxation are long overdue for an adjustment to today’s dollars. As Johnson points out, unlike income tax brackets and standard deductions, which are adjusted annually, the Social Security income thresholds have not been adjusted for inflation since benefits first became taxable almost 40 years ago.

“This failure to adjust the income thresholds is negatively viewed by older taxpayers as a form of double taxation and even described as ‘ageist’ in the comments we receive,” Johnson says. “The number of older taxpayers who pay taxes on a portion of their benefits today is far higher today than the 10% that was originally estimated to be affected by the tax in 1984, when the tax became effective.”

Broadly speaking, Social Security recipients can owe taxes on up to 85% of their Social Security benefits when their combined income is greater than $25,000 for single filers or $32,000 for couples filing jointly. According to Johnson, had these income thresholds been adjusted annually like tax brackets, the $25,000 level today would be roughly $73,000, while the $32,000 level would be $93,200.

Johnson cites figures published by the Congressional Research Service in 2020 to demonstrate the income hit these taxes deliver to retirees. According to the CRS, benefit taxes reduce the total amount of benefits paid by 6.6%, but Johnson says that percentage could quickly climb this tax season and next year, due in large part to the unusually high COLAs in 2022 and 2023.

In basic terms, to determine whether benefits are taxable, taxpayers should take half of the Social Security income and add it to other income to determine “provisional income.” Other relevant income includes pensions, wages, interest, dividends and capital gains.

In the end, Johnson says, the calculation of taxable Social Security benefits depends on the level of benefits and the amount of other (non-Social Security) income and can affect even those with modest incomes.

Revenue Considerations and Social Security Solvency

As Johnson points out, the taxation of benefits is an important source of revenue for Social Security and Medicare. For example, the revenues from the taxation of Social Security benefits at the 50% level is estimated by the Social Security Trustees to provide about $48.8 billion in income for Social Security in 2023 and to cover about 4% of program costs.

Revenues from the 85% level of taxation, on the other hand, go to Medicare, and the Social Security Trustees estimate Medicare will receive about $34.9 billion in revenues from the taxation of Social Security benefits, covering an estimated 8.5% of program costs in 2023.

Of course, the bulk of the funds used to pay for Social Security come out of working Americans’ paychecks. Echoing the comments of other advocates, Johnson says public survey data shows the vast majority of Americans agree on the importance of Social Security — and on the best ways to shore up the program’s finances.

Depending on the survey one points to, Johnson explains, as many as three in four Americans say they don’t mind paying for Social Security, and they strongly value the benefit for themselves and their families, and for the security and stability it provides to millions of retired Americans, disabled individuals, and children and widowed spouses of deceased workers.

According to Johnson, there is broad bipartisan agreement among working Americans that, instead of raising the retirement age or cutting benefits, Congress should gradually eliminate the cap on earnings that are taxed for Social Security, especially if the benefits formula was adjusted to allow higher earners to garner a higher benefit in retirement. This cap is set at $160,200 for 2023.

Similar numbers of Americans slowly raising the Social Security tax rate that workers and employers each pay, Johnson says.

(Image: Adobe)

John Manganaro

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