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Social Security and COLA: Managing Taxes on Benefits

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The 5.9% Cost-of-Living Adjustment (COLA ) increase for Social Security and Supplemental Security Income recipients for 2022 could lead to additional taxes in the 2023 tax year. Many retirees may not know that their Social Security benefits can be taxable—and they might end up owing income taxes they didn’t plan on.

A Senior Citizens League survey found that more than half (51%) of respondents didn’t expect to pay taxes on their Social Security benefits.1 Meanwhile, the U.S. Social Security Administration estimates that almost half (40%) of all U.S. retirees do.2 The jump in COLA—the highest in decades—may widen this disparity between people’s expectations and reality.

of U.S. retirees pay taxes on Social Security benefits. The recent COLA increase could mean an increase in taxes for some.*

Money lost to taxes on Social Security can add up. The Congressional Research Service projected that the average federal income taxes affected taxpayers would owe was $3,211.3

No one ever wants to pay more in taxes. And with higher inflation eating away at purchasing power, it’s even more important for retirees to contain the tax cost.

Assessing the Social Security Tax Issue

Before claiming Social Security, it’s good to know where the Internal Revenue Service stands on taxing benefits.

Social Security makes up a big chunk of people’s retirement income. For Social Security beneficiaries age 65 and older, 37% of men and 42% of women get 50% or more of their income from Social Security, according to the Social Security Administration. This is part of the reason why determining the best time to start receiving benefits as well as having a smart investing strategy are so important.

How to Calculate Provisional Income

Adjusted Gross Income

Tax-exempt income

50% of Social Security

Provisional Income

According to the IRS, 85% of an individual’s Social Security benefits are eligible to be taxed if the person’s provisional income is higher than stated IRS income limits. The IRS calculates provisional income by adding the recipient’s adjusted annual gross income, plus any other tax-exempt income, plus 50% of all Social Security benefits.

Single federal tax filers who report $25,000 or more in provisional income, and married couples filing jointly with $32,000 or more may have up to 85% of their total Social Security benefits subject to taxes.

If your provisional income reaches the IRS income threshold, the amount of Social Security taxes due will depend on your annual income and tax status as shown here:

For individual tax filers

  • If income is between $25,000 and $34,000, up to 50% of your Social Security benefits are taxable.

  • If income is above $34,000, up to 85% of your Social Security benefits are taxable.

For married filing jointly filers

  • If combined income is between $32,000 and $44,000, up to 50% of Social Security benefits are taxable.

  • If combined income is above $44,000, up to 85% of Social Security benefits are taxable.

Reviewing your annual Social Security benefit statement with your financial professional—which shows benefit payouts for the current year—can help you make more informed decisions on your benefit withdrawal strategy and potential tax implications.

Managing Social Security Taxes

Inflation is likely to run higher than its decades-long 2% rate. That means COLA increases will likely be higher too. Plan to minimize the tax burden on your Social Security benefits with these tips.

Adjust your withholding and supplemental income strategies to anticipate COLA. If you have a part-time job, keep an eye on the amount you earn so a COLA boost to your Social Security benefit payment doesn’t push you over an income threshold. Also, consider having taxes withheld in the current year to help lessen a larger tax bill the next year.

Withhold taxes on IRAs or a company pension. Current-year tax withholdings can save money on taxes the following year in other areas, too. For instance, if you take individual retirement account (IRA) or pension plan distributions, you can ask the IRS to withhold the taxes you expect to owe on Social Security benefits this year to alleviate higher taxes next year.

In general, your retirement plan custodian will withhold 10% on taxable distributions, unless you give that custodian different withholding instructions. By and large, you can adjust future IRA plan withholdings at any time. Talk to your IRA plan custodian for more information.

Use IRS Form W-4V. With Form W-4V, you can opt to withhold 7%, 10%, 12% or 22% of your monthly Social Security income and apply it to next year’s taxes.

Consider a Roth IRA. Roth IRA contributions are made with after-tax dollars. You pay no taxes when the money is withdrawn as a qualified distribution. As a result, Roth IRA fund withdrawals in retirement won’t count as provisional income and are deemed as tax-free distributions.

Space out one-time cash events. That big check you might be expecting for selling your business, an inheritance, or another one-time large cash payment event could tip you into an income bracket where you’ll owe tax on Social Security benefits.

Consider spreading out the payments as installments over multiple tax years instead of as a lump-sum payment. Along with potentially helping curb Social Security tax payments, doing so might even move you into a lower tax bracket.

Curb retirement plan withdrawals. If you have a large asset portfolio, you may want to reduce withdrawals from a retirement account. Any cash withdrawn from a 401(k) or Traditional IRA counts as income the same year the money is taken out.

When you reduce the amount you take or stop taking money out of a 401(k) plan or Traditional IRA, that’s money that won’t be counted toward any provisional Social Security income threshold.

Such a move may not be possible if you must take required minimum distributions out of these types of retirement accounts, so check with the plan sponsor first before curbing any plan payouts.

The Takeaway on Social Security Income and Taxes

You don’t have to get a big tax bite taken out of your Social Security payments. Staying aware of the latest policies can help you plan for tax impacts.

Talking to your financial advisor or tax professional about Social Security tax implications can also help you make informed decisions about Social Security and income planning (including investment strategies).

Social Security Is Never One Size Fits All

Beside taking steps to reduce potential tax burdens, learn more about how to get the most out of your benefits before you file.

Source: U.S. Social Security Administration, 2022. Half of All Social Security Households May Pay Tax on Benefits. Social Security Administration: Understanding the Benefits, pg. 10. Social Security: Taxation of Benefits; Congressional Research Service, pg. 4.

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.

Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.

Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.

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.