Since 1975, Social Security checks have received an annual cost-of-living adjustment (COLA) to protect the buying power of benefits from inflation. Given the critical role Social Security plays in retirement and the toll inflation has taken on the economy this year, many retired workers are anxiously awaiting their “raise” in 2023.
Here are four important details about the massive Social Security COLA coming next year.
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1. The Social Security COLA in 2023 will be the largest COLA since 1982
The Social Security Administration (SSA) calculates COLAs based on how the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) changes in the third quarter of each year. For example, the CPI-W increased 8.7% in the third quarter of 2022, so Social Security benefits will get an 8.7% COLA in 2023.
The last time retired workers received a raise that big was 1982. In fact, the 8.7% COLA coming in 2023 is the fourth-biggest raise since COLAs became automatic in 1975. That illustrates just how hard inflation hit the U.S. economy over the past year.
2. The 8.7% COLA in 2023 could underestimate the pace of inflation
Social Security COLAs are not a perfect solution. The formula uses CPI-W data from the current year to estimate inflation in the next year, meaning COLAs can easily overestimate or underestimate the pace of rising prices. The 5.9% COLA applied to Social Security checks in 2022 is a perfect example.
At the time, the 5.9% COLA was the largest increase in benefits since 1983, but it still grossly underestimated inflation in 2022, causing Social Security checks to lose buying power. That same outcome is possible in 2023, so retired workers should continue to monitor inflation and budget accordingly.
3. Some beneficiaries will get a bigger tax bill in 2024
The federal government started taxing Social Security benefits in 1984, but the income thresholds were high enough at the time that fewer than 10% of beneficiaries actually owed taxes on their benefit checks. Unfortunately, the income thresholds have never been adjusted for inflation, so each COLA since 1984 has pushed more beneficiaries above the income limit.
Today, about 50% of beneficiaries pay federal tax on Social Security benefits, and the 8.7% COLA in 2023 will push more recipients over the limit. That means some retired workers will get a bigger tax bill in 2024.
Tax liability depends on filing status and combined income, which is defined as modified adjusted gross income plus half of Social Security benefits. The chart below illustrates the combined income thresholds for beneficiaries based on their tax return filing status.
