There will be a few changes to Social Security in 2025, but one of the changes that certain seniors should be aware of is the 2.5% increase in their payments as a result of the annual cost of living adjustment.
Although an increase in benefits always appears to be a good thing, and many were dissatisfied because of the little rise in their benefits, some retirees may be less delighted, given that this could push them over the federal tax threshold for their benefits.
Contrary to popular assumption, Social Security benefits are not taxed separately. All but nine states have an exemption from collecting Social Security (and the list grows lower each year), and federal taxes do not apply to individuals who rely solely on benefits.
Instead, you pay taxes on your “combined income.” So, what is the combined income? Your overall income determines whether your Social Security benefits are taxable and how much of them are subject to federal income tax. It’s calculated as:
- Your adjusted gross income (AGI)
- Anynontaxable interest you earn (like municipal bond interest)
- Half of your Social Security benefits
The total of these sums determines whether or not you are required to pay federal taxes on your Social Security income. Keep in mind that even if states do not tax benefits, other types of income may have already been subject to state taxes, so this only affects individuals who exceed the federal levels.
How much of your income is taxable?
Depending on your total income, you may owe taxes on up to 50% or even 85% of your benefits. Here’s the breakdown:
- Up to 50% of benefits 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% of benefits taxable:
- Single filers with combined income over $34,000
- Joint filers with combined income over $44,000
Why do so many retirees owe taxes on their Social Security benefits?
Currently, around 40% of Social Security recipients pay federal income taxes on their payments. According to the Senior Citizens League, a nonpartisan senior advocacy organization, this figure rises to over 50% among retirees.
The group claims that this is significantly greater than it should be due to antiquated tax standards.
The problem is with the previously indicated combined income thresholds, which have not changed since Social Security benefits became taxable in 1984, following the first program shortfall. With no inflation adjustments to the criteria, more pensioners have ended up paying taxes on their pensions over the years.
Originally, less than 10% of Social Security recipients were anticipated to pay taxes. According to one article, “Initially, less than 10% of Social Security participants were expected to pay taxes on their benefits. Now, Uncle Sam is reaching into the pockets of roughly half of the recipients.”
Minimizing Benefit Taxes
Fortunately, there are ways to reduce or eliminate your tax liability. The objective is to lower your total revenue. One straightforward solution is to withdraw slightly less from traditional retirement savings or taxable assets to offset the 2.5% Social Security increase.
You may be able to save money if you keep your total income below the tax levels. This may not always be an option due to the Internal Revenue Service’s Required Minimum Distributions rules.
Even if it is not practical, there are plenty other solutions to explore. For example, appropriately managing your withdrawals from tax-advantaged accounts or timing your income can help you manage your overall income.