We were all pleased to hear the news of a Social Security cost of living adjustment (COLA) last month. Those currently drawing Social Security benefits will receive a 2.8 percent increase in their payments, beginning in January. For those still planning for retirement, it’s encouraging to see that benefits will be subject to periodic adjustments to account for inflation.
So, a Social Security COLA is good news. But because changes in income can trigger changes in taxation, this is an issue to watch carefully throughout retirement, or as you continue to plan.
One thing to remember is that some Social Security recipients do pay taxes on a portion of their benefits. Therefore, an increase in payments can also trigger a slight increase in taxes.
These taxes are based upon something called “combined income”, which consists of your adjusted gross income, nontaxable interest you receive, and one half of your Social Security payments. You might owe taxes on up to half of your Social Security benefits when…
- Combined income falls between $25,000 and $34,000, and you file taxes as an individual
- Combined income falls between $32,000 and $44,000, and you file taxes jointly as a married couple
Or, you might owe taxes on up to 85 percent of your Social Security benefits when…
- Combined income is more than $34,000 and you file taxes as an individual
- Combined income is more than $44,000 and you file taxes jointly
For some retirees already falling on the upper edge of a tax bracket, it is possible that an increase in Social Security benefits will bump them into the next higher bracket. In that case, your income tax bill could increase.
We do have potential solutions for this problem, including adjusting retirement account withdrawals downward just a bit. In some cases, other measures might be helpful. Give us a call, and we can help you determine whether the Social Security COLA could trigger increased taxes, and help you decide how to handle the situation.