In 2025, Social Security recipients will see a 2.5% increase in their benefits, thanks to the annual Cost-of-Living Adjustment (COLA). While any increase in benefits may seem like good news, some seniors may find themselves facing unexpected tax consequences, making the boost not as advantageous as it appears.
Although Social Security benefits themselves are not directly taxed in most cases, the issue lies in a concept called “combined income.” Unlike other benefits, Social Security payments can become taxable depending on your combined income, which is calculated by adding:
- Your adjusted gross income (AGI)
- Any nontaxable interest you earn (such as from municipal bonds)
- Half of your Social Security benefits
The total of these amounts determines whether you will owe federal taxes on your benefits. Even if your state doesn’t tax Social Security, your other income may already be subject to state taxes, so this is only a concern for those whose combined income exceeds certain thresholds at the federal level.
How much of your benefits can be taxed?
The amount of your benefits that are taxable depends on your combined income. Here’s how it breaks down:
- Up to 50% of benefits are taxable if your combined income is:
- Single filers: $25,000 to $34,000
- Joint filers: $32,000 to $44,000
- Up to 85% of benefits are taxable if your combined income exceeds:
- Single filers: $34,000
- Joint filers: $44,000
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Why are so many retirees paying taxes on their Social Security benefits?
Currently, about 40% of all Social Security recipients pay federal taxes on their benefits, and for retirees, that figure rises to around 50%. The issue stems from outdated income thresholds that have not been adjusted for inflation since they were introduced in 1984. As a result, more retirees are finding themselves taxed on their Social Security benefits, even though less than 10% of recipients were initially expected to pay taxes when the rule was first implemented.
Minimizing taxes on your benefits
There are strategies available to reduce the amount of tax you pay on your Social Security benefits. One common tactic is to manage your overall combined income by adjusting withdrawals from traditional retirement accounts or taxable investments. This can help keep your combined income below the thresholds that trigger taxes on your benefits. However, if you are subject to Required Minimum Distributions (RMDs) from retirement accounts, this may be more difficult to manage.
Other approaches include planning the timing of income withdrawals and carefully managing distributions from tax-advantaged accounts to reduce your combined income in a way that minimizes or even eliminates taxes on your Social Security benefits.
In conclusion, while the 2.5% COLA increase in 2025 may provide some financial relief, it’s important for retirees to be mindful of how this change could impact their taxes. Being proactive about managing your combined income and understanding how tax rules apply can help you navigate the complexities of Social Security taxation and make the most of your benefits.
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