Each year, the Social Security Administration enacts a cost-of-living adjustment (COLA) meant to keep benefits in line with inflation. Not surprisingly, high inflation in 2021 led to a massive 5.9% COLA in 2022, but inflation has continued to accelerate this year, which means seniors may see a bigger raise next year.
In fact, The Senior Citizens League says the COLA may clock in at 8.7% in 2023. That would be the largest increase in benefits in the last four decades. But seniors must be aware of a few important caveats.
More seniors may pay taxes on benefits
Social Security was first subject to federal income tax in 1984, though less than 10% of seniors actually had to pay taxes on benefits at the time, simply because most fell short of the income thresholds. However, those thresholds have never been adjusted for inflation, and that has created a problem.
Each COLA enacted since 1984 has pushed more seniors over the income limit, exposing a greater percentage of Social Security benefits to taxation. In fact, about 40% of seniors now pay taxes on their benefits, according to the Social Security Administration, and a massive COLA in 2023 means that figure will probably keep rising next year.
How much money you owe (if any) depends on two things: combined income and filing status. For context, combined income is defined as adjusted gross income plus nontaxable interest plus half of your Social Security benefits. If that figure hits $25,000 for individual filers or $32,000 for joint filers, up to 50% of benefits may be subject to federal income tax. But if combined income exceeds $34,000 for individual filers or $44,000 for joint filers, up to 85% of benefits may be subject to federal income tax.
To know for certain, you should receive a Social Security Benefits Statement (Form SSA-1099) each January that details the benefits you received in the previous year. You will used that form when filing your federal income tax return to determine whether any portion of your benefits are subject to tax.
The actual COLA may be less than 8.7%
The Social Security Administration calculates COLAs using inflation data from the third quarter, which runs from July through September. That means the 8.7% COLA is not set in stone, and it explains why COLA forecasts have fluctuated so much in recent months.
For instance, when inflation hit a 40-year high in June, The Senior Citizens League said an 11.4% COLA was possible. But that forecast was revised down to 9.6% after inflation slowed in July, then to 8.7% when inflation again slowed in August. That means the actual COLA in 2023 may be less than 8.7% if inflation continues to cool this month.
With that in mind, the Labor Department is set to release September inflation data on Oct. 13, and seniors should expect to see an official COLA figure from the Social Security Administration that same day.
The COLA in 2023 may not offset the impact of inflation
The Social Security Administration measures inflation using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), but many experts see that as a problem. The CPI-W tends to underemphasize spending categories most relevant to seniors — think medical care and housing — because it is tracks purchases made by individuals in the workforce.
That issue has caused Social Security benefits to lose 40% of their buying power over the last two decades, according to The Senior Citizens League. And unless a better measure of inflation for seniors is adopted, that trend will likely continue in the coming years. That means the COLA in 2023 may fail to completely offset the impact of inflation, so seniors should budget their money cautiously.
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