Income Tax and Social Security Updates Ease Inflation Pain

The rate at which consumer prices are rising has come down quite a bit in recent months, but increased costs are still taking a bigger bite out of Americans’ wallets than they are used to.

There are important exceptions: The IRS applies an annual adjustment to income tax brackets to account for inflation. They also increased the standard deduction used by taxpayers who don’t itemize. This will allow Americans to shield more of their money from taxes, albeit just enough to mitigate the rise in the cost of living. Social Security recipients, meanwhile, received a benefit increase via the annual cost-of-living adjustment (COLA).

Tax Brackets Adjusted, Social Security Payments Raised

The IRS is required by statute to adjust certain key tax metrics to account for inflation. Because the U.S. has a progressive income tax system, increases in taxable income “travel” through the tax brackets. As in 2023, this year’s federal income tax brackets are 10%, 12%, 22%, 24%, 32%, 35% and 37%.

The 2023 12% bracket for the 2023 tax year, for example, was imposed on taxable income between $11,001 and $44,725 for single filers. For 2024, the 12% bracket is bumped up to start at $11,601 of income and runs to $47,150.

The inflation adjustment to the tax brackets serves as a mechanism to avoid “bracket creep” where individuals may be subject to a higher income tax rate due to the income keeping pace with inflation.

The IRS also raised the standard deduction to $14,600 for single filers in 2024 from $13,850 in 2023. The corresponding figures are $21,900 for heads of households, from $20,800, and $29,200 for married couples filing jointly, from $27,700.

Many other tax exemptions and credits were also positively impacted by the higher inflation rate. For instance, the federal estate tax exemption increased to $13.61 million ($27.22 million for married couples) up from $12.92 million ($25.84 million for married couples) in 2023.

Currently, 43 states plus the District of Columbia impose income taxes, and some also adjust their income tax brackets for inflation.¹

COLA: How Does Inflation Impact Social Security Benefits?

For the 71 million Americans who receive Social Security benefits, COLA increased the benefits by 3.2% this year. (Last year’s 8.7% bump was the biggest increase in 40 years.²) The Social Security Administration estimates that benefits will increase by more than $50 per month on average this year.

Cost-of-living adjustments may be mandated by law, but laws can and do change. As government budget showdowns loom and the cost of Social Security swells with the aging U.S. population, the adjustments could be reduced in the future. A tax or financial advisor can help you determine what this means for your own plans.

Adjustments for Medicare Premium Increases

For most retirees, Medicare Part B premiums are subtracted directly from Social Security payments.

When Medicare Part B premiums increase due to higher health care costs and inflation, your Social Security payments won't be reduced. The Social Security Administration and the Centers for Medicare and Medicaid Services use a "Hold Harmless" provision to ensure there's no decrease in your existing Social Security benefits.

Your Mortgage May Insulate You from Inflation ... Up to a Point

Keep in mind that during periods of higher inflation, mortgage rates tend to increase. If you own a home and you’re paying it off with a fixed-rate mortgage, you may be insulated doubly from the effects of inflation.

Your home value is likely to have risen substantially in the last few years, and your mortgage payments are holding steady, while individuals with an adjustable-rate mortgage (ARM) may be impacted by higher interest payments as interest rates rise.

The bad news is that if you have an adjustable-rate mortgage, you could be in for serious sticker shock the next time the interest rate resets. And if you are searching for a new home, the cost to find an affordable one can be more difficult these days. Tomorrow could be a different story, though. Home prices have dipped since June as the Federal Reserve’s more restrictive monetary policy has taken hold.

If the market continues to soften, and especially if the broader economy falls into recession, there is a risk that homeowners who have benefited from rising inflation will give back some of their gains, and maybe more.

But while the housing market is cooling, it’s far from cold. And even if the economy tips over into recession, economists note that homeowners aren’t in nearly the precarious position they were during the 2008 Great Recession, when far more Americans were upside-down on home loans.

Easing the Burden of Inflation

Inflation has been hard on American households. But cost-of-living adjustments may limit the amount of income subject to income tax and boosts to Social Security benefits may be helping. Moreover, the strength that some assets, most notably your home, display during bouts of inflation may be helping to ease the pain of rising prices for many Americans.