Will Your Taxes on Social Security Income Spike When You Get Your Next COLA Increase?

At first thought, I was pretty happy about the idea of getting the largest Social Security COLA (cost of living adjustment) increase in decades, whether it is 6.0%, 6.1%, or 6.2%! It seems no matter what that final number is going to be, it will be a big increase. Let’s face it: even with all of the financial pressures and problems we have been dealing with for the past year and a half, the cost of living for Social Security recipients is always a topic of drama and concern. If you aren’t one of “us” now, you will be one day and then you will be much more sensitive to it, I assure you.

Elderly woman’s hands clasping her cane as she considers whether she will have to pay taxes on Social Security income

But what about your income taxes on Social Security income? If you receive Social Security, will your taxes spike because you just got a big COLA increase in 2022?

Thank Goodness You Receive a Monthly Check

For so many, getting that monthly check is a huge chunk of the money that they live on every day. In fact, it is the total amount some people actually try to live on! It wasn’t supposed to be that way when Social Security became a “thing” back in 1935.

It was just supposed to be another part of one’s retirement income. If you are smart, you saved for retirement and now you actually draw from that money along with your Social Security payments to assist you with your day-to-day retirement expenses. That means you have additional income and sometimes that income is taxable income.

Does that may mean you’ll pay taxes on Social Security income and all of your retirement money too? It just might be.

The Taxes You Hate

You can thank Ronald Reagan for first taxing your Social Security money. Beginning with 1984, 50% of the benefits were to be considered as taxable income for income-tax purposes for persons with an Adjusted Gross Income of $20,000 if single and $25,000 if married. The proceeds from such taxation would be credited to the OASDI Trust Funds under a permanent appropriation.

Congress passed the tax and President Reagan signed it into law in 1983. That’s the way it is some 40 years later with only the thresholds for taxation having been altered, and not very much I might add.

Social Security income is generally taxable at the federal level, though whether or not you have to pay taxes on your Social Security benefits depends on your total income. If you have other sources of retirement income, such as a 401(k) or a part-time job, then you should expect to pay some income taxes on your Social Security benefits.

However, if you rely exclusively on your Social Security checks, you probably won’t pay taxes on your benefits.

State laws vary on taxing Social Security.

Social Security Income

According to the IRS, the quick way to see if you will pay taxes on your Social Security income is to take one half of your Social Security benefits and add that amount to all your other income, including tax-exempt interest. This number is known as your combined income (combined income = adjusted gross income + nontaxable interest + half of your Social Security benefits).

If your combined income is above a certain limit (the IRS calls this limit the base amount), you will need to pay at least some tax.

If your Social Security income is taxable, the amount you pay in tax will depend on your total combined retirement income. However, you will never pay taxes on more than 85% of your Social Security income.

Calculating Your Social Security Income Tax

For the 2022 tax year, single filers with a combined income of $25,000 to $34,000 must pay income taxes on up to 50% of their Social Security benefits. If your combined income was more than $34,000, you will pay taxes on up to 85% of your Social Security benefits.

For married couples filing jointly, you will pay taxes on up to 50% of your Social Security income if you have a combined income of $32,000 to $44,000. If you have a combined income of more than $44,000, you can expect to pay taxes on up to 85% of your Social Security benefits.

If 50% of your benefits are subject to tax, the exact amount you include in your taxable income (meaning on your Form 1040) will be the lesser of either:

  • Half of your annual Social Security benefits or
  • Half of the difference between your combined income and the IRS base amount

So interestingly, a large part of the COLA increase in your benefits for this year could be eliminated via the additional tax it can generate because you now have crossed over a threshold like $44,000 for a married couple.

Think about it this way. If you and your spouse now get monthly checks of a total gross amount (before Medicare deductions) of $4,000 a month and you get a 6.0% increase for 2022, your new annual Social Security income goes from $48,000 a year to $50,800 a year. That increase, when added to other income you receive that is taxable, will be eroded by the federal taxes.

State Taxes on Social Security Benefits

Everything I have said here so far is about your federal income taxes. Depending on where you live, you may also have to pay state income taxes.

There are 13 states that collect taxes on at least some Social Security income. Four of those states (Minnesota, North Dakota, Vermont, and West Virginia) follow the same taxation rules as the federal government. So if you live in one of those four states then you will pay the state’s regular income tax rates on all of your taxable benefits (that is, up to 85% of your benefits).

In the remaining states (Colorado, Connecticut, Kansas, Missouri, Montana, Nebraska, New Mexico, Rhode Island, and Utah), benefits are partially taxed with exemptions for income and age.

There are no state taxes on Social Security benefits in any of the other 37 states as of 2021.

Another Hit on Your Monthly Check?

Your Medicare health insurance (if you have it) is deducted right from your Social Security check even before you get it every month. Last year, as it has almost every year, it went up albeit just a small amount ($3.90 a month) mainly due to the pandemic and some consideration for its cost. Next year it will be different and you can expect a larger monthly increase, projected currently to be $10.00 a month per person in monthly cost. That’s $240 more a year per married couple and about 8% of the COLA increase in total gross benefits.

The Impact of Roth IRAs

If you’re concerned about your income tax burden in retirement, consider saving in a Roth IRA. It does not have any tax liability in retirement.

With a Roth IRA, you save after-tax dollars. Because you pay taxes on the money before contributing it to your Roth IRA, you will not pay any taxes when you withdraw your contributions. You also do not have to withdraw the funds on any specific schedule after you retire. This differs from traditional IRAs and 401(k) plans, which require you to begin withdrawing money once you reach 72 years old, or 70½ if you were born before July 1, 1949.

So when you calculate your combined income for Social Security tax purposes, your withdrawals from a Roth IRA won’t count as part of that income. That could make a Roth IRA a great way to increase your retirement income without increasing your taxes in retirement.

Another thing to note is that many retirement plans allow individuals, aged 50 years or older, to make annual catch-up contributions. For 2021, you can make catch-up contributions up to $1,000. These must be made by the due date of your tax return. You have until April 15, 2022 to make the $1,000 catch-up contribution apply to your 2021 Roth IRA contribution total.

Final Thoughts

We all want to pay as little in taxes as possible. You can save on your taxes in retirement simply by having a good plan.

In retirement, if you have enough retirement income that you’re paying taxes on Social Security benefits, you’re probably in decent shape financially. It means you have income from other sources and you’re not entirely dependent on Social Security to meet living expenses. Alternate streams of income now and in retirement are always a good thing even if you do have to pay income taxes.

Do you know what your income will be in retirement? Is that income taxable? Have you saved for retirement and if so have you considered a Roth IRA?

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