Seniors who’d been hoping for some good news after struggling with inflation this year finally got some when the Social Security Administration announced an 8.7% cost-of-living adjustment (COLA) for 2023. This will boost the average senior’s check by $147 beginning in January, and some could look forward to an even bigger increase.
But with bigger benefits comes a higher risk of running into an obscure Social Security rule that could send some of your benefits right back to the government. Here’s what you need to know.
Social Security taxes don’t always stop when you leave the workforce
You’re probably aware that you pay Social Security taxes on your income every year. This money helps pay for the benefits of current Social Security recipients, but it’s not the program’s only source of funding. It also taxes the Social Security checks of some seniors.
Your risk of owing federal benefit taxes depends on your provisional income and your tax filing status. Provisional income is defined as your adjusted gross income (AGI) plus any nontaxable interest, which you might have if you own any municipal bonds, and half your annual Social Security benefit. The following table shows how much you might owe:
Tax Filing Status
Taxed on 0% of provisional income up to:
Taxed on 50% of provisional income between:
Taxed on 85% of provisional income greater than:
Single or head of household
$25,000 and $34,000
Married, filing jointly
$32,000 and $44,000
To be clear, if your provisional income falls into the 50% or 85% range above, that doesn’t mean you’ll have to give 50% or 85% of your checks back to the government. That just indicates the amount subject to income tax.
Examples make this easier to understand, so let’s consider a single adult with an AGI of $30,000, no nontaxable interest, and an annual Social Security benefit of $12,000. The $30,000 AGI plus half of their Social Security benefit would give them a provisional income of $36,000. Here’s how the above taxation thresholds would apply:
The first $25,000 of their provisional income is free from Social Security benefit taxation.
They’d owe income tax on $4,500, which is 50% of the $9,000 between $25,000 and $34,000.
They’d owe income tax on an additional $1,700, which is 85% of the remaining $2,000 of their provisional income.
So all told, they’d owe Social Security taxes on $6,200 of their benefits. But the amount they’d actually pay depends on their income tax bracket. That could be as low as 10% or as high as 37%, depending on their annual income.
Why more seniors could owe benefit taxes in 2023
With Social Security benefits increasing next year, more seniors are going to encounter these benefit taxes for the first time. It can lead to a surprise tax bill that could derail your budget pretty quickly. But if you’re aware of how the government taxes benefits, you can anticipate what you’ll owe, and you might even be able to avoid benefit taxes altogether.
One way to do this is by relying upon Roth savings as you near the thresholds for taxation outlined above. You generally don’t owe any taxes on your Roth retirement withdrawals because you paid taxes on your contributions when you made them. So they enable you to spend more money while your tax liability remains the same.
Sometimes, avoiding these benefit taxes isn’t possible, though. If you have to pay, you can choose to make quarterly estimated payments each year or have federal taxes withheld from your benefits. Choosing one of these options can help you avoid a big shock at tax time.
One final thing worth noting is that it’s not only the federal government that taxes Social Security benefits. Twelve state governments tax some of their seniors’ benefits as well. If you live in one of these states, check with your Department of Taxation to learn whether you could owe these taxes. Then, plan accordingly, so you know how this will affect your budget for next year.
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