As we approach 2025, many retirees will see a 2.5% increase in their Social Security benefits, thanks to the annual cost of living adjustment (COLA). While a boost in benefits might seem like a positive change, seniors need to be aware of the potential tax implications that may come with this increase. Although most people welcome higher benefits, for some retirees, the increase could push them over the threshold for federal taxes on their Social Security income.
Social Security Benefits and Federal Taxes: A Closer Look
Contrary to popular belief, Social Security benefits are not directly taxed on their own. Only a few states tax Social Security, with most offering exemptions. However, the amount of federal taxes you owe on your benefits is determined by your “combined income,” which includes more than just your Social Security benefits.
What Is Combined Income?
Your combined income is a key factor in determining whether your Social Security benefits will be taxed and to what extent. It’s calculated by adding:
- Your adjusted gross income (AGI)
- Any nontaxable interest you earn (like interest from municipal bonds)
- Half of your Social Security benefits
The sum of these amounts will decide if your Social Security benefits are taxable and how much of them will be subject to federal income tax.
How Much of Your Benefits Could Be Taxed?
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Depending on your combined income, a portion of your Social Security benefits may be taxable. Here’s how it breaks down:
Up to 50% taxable
- Single filers with combined income between $25,000 and $34,000
- Joint filers with combined income between $32,000 and $44,000
Up to 85% taxable
- Single filers with combined income over $34,000
- Joint filers with combined income over $44,000
This means that depending on your income, up to 85% of your Social Security benefits could be taxed at the federal level.
Why Are So Many Retirees Paying Taxes on Social Security?
Currently, about 40% of Social Security recipients pay federal taxes on their benefits, and for retirees, that figure rises to around 50%, according to the Senior Citizens League, a nonpartisan senior advocacy group. This is a significant increase from the initial expectations when Social Security benefits first became taxable in 1984. Back then, less than 10% of recipients were expected to owe taxes on their benefits.
The root cause of this increase lies in the fact that the combined income thresholds have not been updated for inflation since 1984. As inflation has pushed more retirees’ incomes above these fixed thresholds, more are now subject to taxation on their Social Security benefits.
Strategies for Minimizing Taxes on Social Security Benefits
While the tax situation may seem daunting, there are ways to reduce or even avoid paying taxes on your Social Security benefits. One option is to reduce your combined income by adjusting how much you withdraw from traditional retirement accounts or taxable investments.
By lowering your income below the tax thresholds, you can avoid paying taxes on your Social Security benefits. However, this strategy might not always be viable, especially with the Required Minimum Distributions (RMDs) imposed by the IRS on certain retirement accounts.
For those facing the RMD requirement or other limitations, other strategies can help minimize tax liability. For example, careful planning of your withdrawals from tax-advantaged accounts or timing your income to stay below the tax thresholds can help reduce the amount of your Social Security benefits subject to federal taxation.
Summary
To summarize, while the 2.5% COLA rise in 2025 may benefit retirees, it may also put some over the tax threshold, resulting in taxable Social Security benefits. Retirees can reduce or avoid additional tax liabilities by controlling their combined income and making judicious withdrawals.
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