Social Security benefits will rise 8.7% in 2023 to help
retirees keep pace with inflation. While that is good news for most retirees,
some will find the bigger checks come with a bigger tax bill.
Americans owe taxes on a portion of their Social Security
benefits if they earn more than $25,000 as individuals, or $32,000 as couples.
(When computing taxes on Social Security, the Internal Revenue Service counts
half of a taxpayer’s benefits as part of their income.)
These thresholds have never been adjusted for inflation
since the tax was introduced in 1984 as a way to shore up the program’s
finances. So as the cost-of-living adjustment, or COLA, raises monthly checks
for retired workers, more taxpayers become subject to tax on part of their
benefits.
In 1993, lawmakers added a second threshold, of $34,000 for
single people and $44,000 for married couples, above which up to 85% of Social
Security becomes taxable. In 2021, 46% of retirees paid federal income tax on a
portion of their benefits, up from 8% in 1984, according to the Social Security
Administration.
The average annual Social Security payment for retired
workers will rise to $21,768 in 2023, up $1,740 from $20,028 this year.
Retirees already paying tax on their Social Security may owe
tax on a slightly higher percentage of those benefits next year.
For some, the tax hit could be more significant, said Bill
Reichenstein, head of research at Socialsecuritysolutions.com, which sells
Social Security claiming advice.
For example, the COLA may push some taxpayers into a higher
tax bracket or above the threshold at which 85% of their Social Security
benefits become taxable.
For a small number of higher income retirees, the additional
Social Security income could also trigger costly surcharges on future premiums
for Medicare Parts B and D, which, respectively, cover outpatient and
prescription drug costs. Those premiums can rise steeply if income exceeds
certain thresholds.
That could add more than $2,000 of additional annual premium
expense for some couples, given current surcharges.
To see how the taxes work, consider a couple with $20,000 in
Social Security benefits this year, plus $30,000 of other income, from sources
that might include a pension or 401(k) account. The formula adds half the
couple’s Social Security, or $10,000, to their $30,000 of other income,
yielding what is called a combined income of $40,000.
Since that is $8,000 over the $32,000 threshold at which
benefits become taxable for couples, they must pay tax on half of the $8,000.
As a result, $4,000, or 20%, of their benefits are taxable.
If the same couple has 8.7% more Social Security income in
2023, their total annual benefits rise to $21,740.
If their other income remains the same at $30,000, their
combined income—which includes half their Social Security, or $10,870—will
increase to $40,870 in 2023. Because that is $8,870 above the $32,000 threshold
at which benefits become taxable for couples, half that amount, or $4,435, of
their benefits are taxable. As a result, the taxable portion rises to 20.4% of
their total benefits in 2023.
If the couple is in the 12% federal income tax bracket, they
would pay $532 in tax on their 2023 Social Security benefits, up from $480 this
year, according to Dr. Reichenstein, a professor emeritus at Baylor University.
A couple with a combined income of $50,000 would pay taxes
on $11,100 of their benefits, he said.
That is calculated by taking 50 cents of each dollar of
combined income between $32,000 and $44,000, plus 85 cents of each dollar above
$44,000, the threshold at which up to 85% of benefits become taxable, Dr.
Reichenstein said.
Those figures don’t take into account the state income tax
about a dozen states, including North Dakota, Connecticut and Nebraska, impose
on some Social Security beneficiaries. The IRS has a tool that estimates the
portion of Social Security benefits that are taxable.
Click here for the
original article.