This Year’s COLA Increase Could Be As High As 10.5% – Forbes Advisor

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This year’s sky-high inflation has prompted predictions of a giant Social Security raise for retirees in 2023. The nonpartisan and nonprofit Senior Citizens League is forecasting a 10.5% boost in benefits, which may sound like a boon for Social Security recipients.

But a supersized COLA, or cost-of-living adjustment, could lead to unwanted consequences, including higher taxes and Medicare costs.

How the Social Security COLA Could Rise

The annual Social Security adjustment reflects inflation because it’s based on government data on consumer prices. The final increase for 2023 won’t be announced until October, but even if inflation cools, it’s likely the COLA will still be the biggest in years.

The Senior Citizens League says if prices continue to rise, next year’s Social Security raise could be as high as 11.4% If inflation slows, seniors could see a COLA of about 9.8%—still a big leap.

But if 10.5% is indeed the right number, here’s how benefits would change in 2023:

  • The estimated average monthly Social Security benefit would increase from $1,657 to $1,831—up $174 per month, or $2,088 for the year.
  • The average monthly benefit for a couple who both receive benefits would rise by $289 a month, from $2,753 to $3,042—for an additional $3,468 a year.
  • The maximum benefit for a person claiming Social Security at what the program calls “full retirement age” (generally 66 or 67) would increase from $3,345 per month to $3,696, for an additional $351 per month or $4,212 per year.

Though the increases appear to be good news for older people hard hit by inflation, the numbers don’t factor in what Uncle Sam will take back.

How Social Security Is Taxed

The same government that pays out Social Security also taxes Social Security.

In 1983, Congress first levied federal income taxes on Social Security benefits. Under current law, you can owe tax on up to 85% of your benefits if you’re a single taxpayer with annual income over $25,000 or if you and your spouse file jointly and have combined income over $32,000.

Here’s are closer look at how Social Security benefits are taxed:

  • For single taxpayers:
    • Income of less than $25,000: 0% taxed
    • Income of $25,000 to $34,000: Up to 50% taxed
    • Income of more than $34,000: Up to 85% taxed
  • For spouses filing jointly:
    • Income of less than $32,000: 0% taxed
    • Income of $32,000 to $44,000: Up to 50% taxed
    • Income of more than $44,000: Up to 85% taxed

So, let’s say you receive 2022’s average monthly Social Security benefit of $1,657 and get another $1,200 per month from your IRA, stocks or even a part-time job. You’d have a total income for the year of $34,284.

With an income over $34,000, you would be required to pay taxes on 85% of your annual Social Security benefits of $19,884, or $16,901 worth of your benefits. In effect, your taxable income would increase by that amount, and you could find yourself pushed into a higher tax bracket.

Most Beneficiaries Now Pay Taxes on Social Security

At one time, Social Security taxes were seen as a tax on the wealthy, but the Social Security Administration estimates most of today’s beneficiaries—56%—pay taxes on their Social Security. A 10.5% COLA would push that percentage even higher.

“This is a big concern because a few more years of high inflation and everybody is going to be paying taxes on 85% of their benefits,” says Larry Kotlikoff, a professor of economics at Boston University and the author of “Get What’s Yours,” a book about navigating Social Security.
“This is a hidden benefit cut.”

Recipients also may pay increased state taxes in the states that tax Social Security: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia.

How the Social Security COLA Affects Medicare Costs

A 10.5% Social Security COLA for 2023 would result in some higher-income earners paying more for Medicare Part B (medical insurance) and Part D (prescription drug) benefits.

While the income-related monthly adjustment amount that’s used to determine Part B and Part D premiums is adjusted for inflation, a couple filing jointly and making just a few dollars over one of Medicare’s income thresholds can face huge premium increases.

“If you earn an extra dollar or receive an extra dollar or two of Social Security, your Medicare premiums can go up by $800, $900 or $1,000 [a month],” Kotlikoff says.

With a large Social Security COLA on the way, it’s time to explore what you’re likely to owe in taxes, says Mary Johnson, Social Security policy analyst for the Senior Citizens League.

Johnson urges all Social Security recipients to log into their My Social Security accounts, then discuss their income tax withholding with a knowledgeable financial advisor.

“If you know your taxable income is going to be 10% higher than the previous year, you are going to have to adjust estimated taxes,” Johnson says.

Low-Income Social Security Recipients May Be Hurt Most

Because of next year’s anticipated COLA spike, low-income beneficiaries may see cuts to their income-related benefits like Medicaid, the Supplemental Nutrition Assistance Program (SNAP, popularly known as “food stamps”) and the Medicare Savings Programs (MSP).

Eligibility for these programs is based on the federal poverty level. All of these programs are indexed for inflation, but couples who both get Social Security may receive an increase that throws them over the limit for SNAP or MSP.

These aren’t the only programs affected by an increase in the COLA. Payments to military retirees, disabled veterans, federal and state retirees are also tied to this increase.

Both Kotlikoff and Johnson urge Congress to fix how benefits are calculated.

Johnson also supports a temporary two-year suspension on the federal taxation of Social Security benefits. “Had these income thresholds been adjusted for inflation since 1984, the $25,000 level would today be about $68,400, and the $32,000 level would be $87,550,” Johnson says.

The Social Security Expansion Act, introduced in Congress June by Rep Peter DeFazio (D-OR) and Sen. Bernie Sanders (I-VT) suggests a number of ways to solve Social Security’s insolvency, including indexing taxation. But its chances of passage probably aren’t high because there’s little support in the Senate.

Does the Increase Mean You Should Take Social Security Now Rather Than Wait?

On the positive side, the annual COLAs are gifts that keep on giving. After a person reaches age 62, the increases are added automatically, regardless of when an older person starts taking their benefits.

Plus, the raises are cumulative. So if you receive a 10.5% increase in 2023, the next increase will be based on that total.

If you’re getting or are planning to take spousal, survivor or divorced spouse benefits, you’ll receive this increase and subsequent increases no matter when you sign up.

In other words, there’s no hurry to expedite the date when you take your benefits, Kotlikoff says.

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