In 2025, Social Security recipients will see a 2.5% increase in their benefits due to the annual cost-of-living adjustment (COLA). While a boost in benefits might seem like a positive change, some retirees could find themselves facing unexpected tax implications. Specifically, the COLA increase may push their income above the threshold for federal taxes on Social Security benefits, causing them to pay more than they would have otherwise.
Understanding Social Security Taxation
Social Security benefits are not automatically taxed, but what is taxed is your “combined income.” Combined income is calculated by adding your adjusted gross income (AGI), any nontaxable interest you earn (such as from municipal bonds), and half of your Social Security benefits. The total of these amounts determines whether and how much of your Social Security benefits are subject to federal income tax.
How Much of Your Social Security Benefits Can Be Taxed?
The amount of your benefits that could be taxed depends on your combined income. Here’s how the taxation works:
- Up to 50% of benefits taxable:
- Single filers with combined income between $25,000 and $34,000
- Joint filers with combined income between $32,000 and $44,000
- Up to 85% of benefits taxable:
- Single filers with combined income over $34,000
- Joint filers with combined income over $44,000
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Why Are Many Retirees Paying Taxes on Social Security?
Currently, about 40% of all Social Security recipients pay federal income taxes on their benefits. This number jumps to about 50% for retirees, according to the Senior Citizens League, a nonpartisan senior advocacy group. The reason for this increase is outdated tax rules. When Social Security benefits were first taxed in 1984, the income thresholds were set to determine who would pay taxes on their benefits. However, those thresholds have never been adjusted for inflation, causing more retirees to fall into the taxable category over time.
When the program was first established, fewer than 10% of recipients were expected to pay taxes on their benefits. Now, approximately half of recipients face taxes on their Social Security income.
Minimizing Taxes on Your Social Security Benefits
Fortunately, there are strategies to reduce or avoid paying taxes on Social Security benefits. One simple approach is to manage your combined income. For example, you might consider withdrawing less from traditional retirement accounts or taxable investments, which could keep your total income below the tax thresholds. However, this approach may not always be possible due to Required Minimum Distributions (RMDs) set by the IRS.
In addition to managing withdrawals, there are other planning techniques, such as timing your income and making strategic withdrawals from tax-advantaged accounts, that could help lower your tax burden. By carefully managing your income, you can avoid or reduce the impact of taxes on your Social Security benefits.
Conclusion
While a 2.5% increase in Social Security benefits may seem like a welcome change, it could push some retirees into a taxable income bracket, leading to higher taxes on their benefits. By understanding how combined income works and taking steps to manage it, retirees can minimize or avoid these taxes, ensuring that the COLA increase doesn’t lead to a larger tax bill.
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