More retirees who collect Social Security benefits are going to owe taxes on that retirement income this year and next compared with prior years. And the total amount of tax retirees pay on their benefits is probably going to be higher.
There's a simple reason for that: surging inflation.
Why is surging inflation increasing taxes for older Americans?
Inflation is currently at a 40-year high, with a consumer price index in June showing that goods and services cost 8.6% more than they did a year ago. Unfortunately, this is a problem for seniors for a number of reasons — including the fact it is likely to lead to more taxation of Social Security benefits.
See, Social Security benefits are not taxed at all if your provisional or countable income is below a certain threshold. That threshold is $25,000 for single tax filers and $32,000 for married joint filers. And the provisional income that counts is half of Social Security benefits, all taxable income, and some nontaxable income. Once you go above these limits, though, up to 85% of benefits could be taxed by the IRS depending just how high your earnings go.
The problem that exists for seniors is that these thresholds at which benefits become taxable are not indexed to inflation. They have not changed since the law first introducing taxation of benefits passed in 1983.
So, while fewer than 10% of beneficiaries originally owed these taxes, now about half of all households do — and more are expected to in 2022 and 2023 than in prior years because of higher inflation.
Retirees received a cost-of-living adjustment (COLA) in 2022 that was the largest in around 40 years due to the rapid price increases that were occurring. And the COLA for next year is expected to be even larger. These COLAs are built into the program in order to help ensure benefits don't lose buying power. But since seniors end up with higher benefits, their incomes go up and more will owe Social Security taxes.
Many retirees are also being forced to increase their retirement account withdrawals as a result of inflation. This will push incomes even higher along with the big Social Security raise. And obviously the more households earn, the more of their Social Security benefits will be rendered taxable.
While non-retirees may also see their income go up due to wage growth, ordinary income tax rates are increased to keep pace with inflation, unlike the thresholds at which Social Security benefits become taxed. So this problem is unique to seniors.
Retirees need to prepare to pay for these taxes on benefits
Retirees need to be aware of these unfavorable rules so they are ready to cover their higher tax bills this year, next year, and into the future if their income has gone above the level where benefits become taxable for the first time — or if the amount of their Social Security benefits that is subject to tax is increasing.
By having the right amount withheld from Social Security and adjusting your budget to ensure you are accounting for these taxes, you won't end up facing financial hardship because your larger IRS bill catches you by surprise.
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