In October 2022, the Social Security Administration announced an 8.7% cost of living adjustment for recipients, representing the largest increase since 1981.
This increase is due to rising inflation on necessities across the country, like housing, groceries, gas, and other essentials. Therefore, the adjustment translates to an average increase of $140 per month per individual, or roughly $1,700 per year.
Approximately 70 million Americans receive Social Security benefits. Moreover, as of August 2022, the program provided benefits to 52.5 million people over the age of 65, (in addition to 17.9 million people who were recipients of disability benefits or Supplemental Security Income.)
Overall, this increase is good news for retirees who may be struggling with the wave of inflation that has affected all corners of the country. However, there are some potential hurdles in tax planning and management. Let’s uncover what you need to know about this recent increase, and how to ensure that your current and future retirement income is secure.
What is COLA and How is it Calculated?
The annual cost of living adjustment (commonly known as COLA), has been estimated and awarded since 1975 under a formula that Congress legislated. The Social Security Administration (SSA) creates these adjustments on the Bureau of Labor Statistics’ Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), using statistics and data from the third quarter of the previous year.
In this most recent case, the increased benefits (which will go into effect in January 2023) were adjusted to align with the average inflation rate from July 2022 to September 2022.
COLA sets social security apart from other retirement benefits, (such as savings accounts or private pension plans), as these programs may not adjust over time for inflation. In addition, there is no set cap for a COLA increase, so if inflation increases by 25% each time period, beneficiaries will also see a 25% increase.
How Will These Taxes Affect Your Taxes?
Some recipients have to pay taxes on their social security benefits, particularly if they have an extra income in addition to social security. This includes wages, self-employment income, interest, dividends, or other taxable income that must be reported on an annual tax return.
As a result, (and per the IRS rules), you may pay tax on up to 85% of your social security benefits if one of the following financial situations apply.
For an individual tax return, if your combined income is:
- between $25,000 and $34,000, you may have to pay income tax on up to 50% of your Social Security benefits.
- more than $34,000, you may have to pay income tax on up to up to 85% of your Social Security benefits.
For a joint tax return, if your combined income is:
- between $32,000 and $44,000, then you may have to pay income tax on up to 50% of your Social Security benefits.
- more than $34,000, you may have to pay income tax up to 85% of your Social Security benefits.
The average annual Social Security payment for retired workers was around $20,028 in 2022. However, this is expected to increase to $ 21,768 in 2023, due to the recent adjustment.
As such the COLA might inch some Social Security recipients into a higher tax bracket, impacting their tax return once 2023 rolls arounds. Folks who already pay tax on their Social Security benefits, (due to receiving other income from a pension, 401(k) account, or other source), will likely owe more next year.
The Key to Navigating COLA is Proper Tax Planning
Since COLA is fluid and will continue to change over a lifetime and longer, the smartest thing a retiree or near-retiree can do is make a tax plan and see how their income will be affected across the board.
Whether you have already retired and currently receive benefits, or expect to retire in the next 5, 10, or even 20 years, it’s never too early to assess your costs and ensure that you’re secure no matter what the future brings.
Efficient Tax Planning with Saddock Wealth
At Saddock Wealth, we have helped with tax planning and CPA services for clients in all financial situations and stages of life since 1980. Our team is experts at the changing tax laws and how they may play a role in your everyday expenses and your long-term planning.
Start navigating your retirement plan to ensure that you’re covered no matter what short-term and long-term changes may bring.