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Income Tax and Social Security Updates Help Ease Inflation Pain

Inflation remains stubbornly high, but cost-of-living adjustments to income tax brackets and Social Security payments will help take out some of the sting.

A woman reviews paperwork and considers updates to her finances.

Key Takeaways

Because of higher inflation, the IRS’ annual adjustment to income tax brackets is higher than it has been in recent years.

The Social Security cost-of-living adjustment will increase benefits by 8.7% this year, the biggest increase in 40 years.

These changes are designed to shield taxpayers and Social Security recipients from the corrosive effects of inflation.

Inflation remains a worry. The rate at which consumer prices are rising has come down 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 annual inflation adjustment that the IRS applies to income tax brackets to account for inflation is greater in 2023 than in recent years, as is the increase in the standard deduction used by taxpayers who don’t itemize among many tax rules that are positively impacted by the higher inflation rate. 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 one of the largest benefit increases ever 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. The IRS increased the starting point of each bracket by about 7% for 2023 tax brackets.

The 2022 tax year 12% bracket is imposed on taxable income between $10,276 and $41,775 for single filers. For 2023, the 12% bracket is bumped up to start at $11,001 of income and runs to $44,725.

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

Tax Bracket Creep

The increase in income tax liabilities without a corresponding increase in “real” income (adjusted for inflation).

The IRS also raised the standard deduction by 7%, to $13,850 for single filers in 2023 from $12,950 in 2022. The corresponding figures are $20,800 for heads of households, from $19,400, and $27,700 for married couples filing jointly, from $25,900.

Many other tax exemptions and credits were also positively impacted by the higher inflation rate. For instance, the federal estate tax exemption increased to $12.92 million ($25.84 million for married couple) up from $12.06 million ($24.12 million for married couple) in 2022.

Currently, 43 states impose income taxes, and some also adjust their income tax brackets for inflation.1

How Does Inflation Impact Social Security Benefits?

For the 70 million Americans who receive Social Security benefits, the cost-of-living-adjustment increased the benefits by 8.7% this year, the biggest increase in 40 years.2 The IRS estimates that average monthly payments will increase to $1,827 from $1,681 for individuals, and to $2,972 from $2,734 for couples.

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.

Your Mortgage May Insulate You From Inflation…Up to a Point

Housing prices soared during the Covid-19 pandemic; the S&P Case Shiller U.S. National Home Price Index rose 37.9% between the end of 2019 and last January.

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.

Planning Pointer

If you are in the process of purchasing a home and deciding between fixed vs. adjustable-rate mortgages, several considerations should be taken into account such as cash flow, the length of time you will remain in the home, the current interest rates and potential future rates etc.

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 in during the 2008 Great Recession, when far more Americans were upside-down on home loans.

The good news is the average homeowner’s loan-to-value (LTV) ratio—how much is owed on a mortgage divided by the present assessment of a home’s value—was 43.6% in the third quarter of 2022, significantly lower than the 71.3% LTV seen in the first quarter of 2010, according to CoreLogic3, a property data company. Therefore, today’s homeowners are in a much better position to weather the current housing slowdown and a potential recession than they were during the earlier downturn.

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.

Looking to Keep More of What You Earn?

Get more information about how tax rules affect your investments.

State Individual Income Tax Rates and Brackets for 2023," Tax Foundation, February 21, 2023.

“What a record 8.7% Social Security cost-of-living adjustment could mean for taxes on benefits," CNBC, Oct. 20, 2022.

“Homeowner Equity Insights: Q3 2022,” CoreLogic, Dec. 9, 2022.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.