Inflation has been hitting everyone's wallets all year long. With the cost of everything from fuel to pasta going up, a 40-year high in the cost-of-living-adjustment (COLA) for social security sounds like a good thing. But is that all there is to it?
The answer is complicated. For those already retired or considering retiring in 2023, it's not as simple as getting an extra approximately $140 per month. The retiree's "paycheck" usually depends on income from several sources: social security, pensions, tax-deferred retirement accounts such as 401(k)s and IRAs, taxable accounts and interest-bearing savings accounts, and other interest-bearing investments.
It's critical to ensure your retirement income is subject to the least amount of taxes possible. Since up to 85% of social security benefits are taxable, it's essential to look at your entire financial picture from a tax perspective.
While social security has increased, the Federal Reserve's attempts to curb inflation have focused on raising interest rates, and more increases are in store. Short-term rates will likely hit more than 4% by the end of 2022 after years of zero-percent interest on cash. This can increase your taxes because interest income is taxable at the ordinary income tax rate. Many retirees hold enough cash to fund several years of living expenses – so it's worthwhile to do the math and figure out how this may change your tax picture.
What's Happening With Social Security Benefits?
The COLA for 2023 is 8.7%, which translates to an average increase of about $140 per month. All but 15% of social security benefits are taxable, and the percentage subject to taxes depends on your income.
If you file an individual tax return and have a combined income between $25,000 and $34,000, you may have to pay tax on up to 50% of your benefits. If you exceed $34,000, up to 85% of your benefits may be taxable.
If you file a joint return, combined income between $32,000 and $44,000 may result in up to 50% of benefits being taxed. Over $44,000 exposes you to a potential tax of 85% of your benefits.
What Happens if You Work While In Retirement?
The monthly benefit for existing retirees is just one of the impacts of the COLA. Other parts of social security are adjusted as well.
With the full retirement age (FRA) nearing 67 for many retirees, it's becoming increasingly common to retire from full-time work before you reach FRA. But many retirees take on a part-time job for various reasons, including personal fulfillment, a desire to stay busy, and a need to supplement income. The problem is that until you reach full retirement age, social security reduces your benefit if your income exceeds certain limits.
If you are under FRA for the entire year of 2023, $1 in benefits will be withheld for every $2 in earnings that exceed $21,240. If you reach FRA in 2023, $1 in benefits will be withheld for every $3 in what you earn over $56,520 before reaching FRA.
Once you reach FRA, there is no impact on your benefits, no matter how much you earn.
The Sources of Your income Are Important.
The income tax brackets have also increased – so there is a little more flexibility. The new brackets are as follows:
10%: $1-11,000 for singles and $0-$22,000 for couples
12%: $11,001-$44,725 for singles and $22,001-$89,450 for couples
22%: $44,726-$95,375 for singles and $89,451-$190,750 for couples
24%: $95,376- $182,100 for singles and at $190,751-$364,200 for couples
32%: $182,101-$231,250 for singles, and $364,201- $462,500 for couples
The key is to be proactive about tax planning. You may consider a Roth conversion to fill up lower tax brackets if you are in early retirement. You'll be taxed on the amounts you convert, but once invested in the Roth, the funds will grow tax-free, and you won't be taxed on future withdrawals. (Certain rules do apply)
But you'll need to be thoughtful and consider your entire picture. Increases in social security, combined with increases in taxable interest income (remember those I Bonds that are paying close to 10%?), along with withdrawals from tax-deferred retirement accounts, can push ordinary income higher.
It may be enough to bump you into a higher level of taxation on social security.
Suppose you're getting insurance under the Affordable Care Act with a subsidy. In that case, you'll want to be careful that income doesn't get to a level that decreases or eliminates your subsidy amount.
The Bottom Line
Cost-of-living increases in social security are permanent and can be seen as one upside of the inflationary environment we've been in for the last couple of years. But for retirees, it's essential to consider each piece of your income and taxation and to understand the moves you can make to keep more money in your pocket.
This work is powered by Advisor I/O under the Terms of Service and may be a derivative of the original.
All written content on this site is for information purposes only. Opinions expressed herein are solely those of Collins Wealth Management unless otherwise specifically cited. Material presented is believed to be from reliable sources, and our firm makes no representations as to another party's informational accuracy or completeness. Before implementation, all information or ideas should be discussed in detail with an advisor, accountant, or legal counsel.
Comments