How Social Security Cost-of-Living Adjustments Affect Your Taxes

Social security benefits are poised to increase more than in the past 40 years. The cost-of-living adjustment (COLA) will be a whopping 8.7% for beneficiaries in 2023. The increase will undoubtedly come as a welcome change as the nation grapples with rampant inflation.

However, the total amount of the increase may not find its way into the bank accounts of some recipients. Two factors could impact how much you receive: Medicare Part B premiums and taxes.

Medicare Part B Premiums

Every year, the cost of Medicare Part B coverage changes. Furthermore, your monthly social security check deducts the premiums paid toward the program. Fortunately, for 2023, the premiums for Medicare Part B will decrease by $5.20 to $164.90 per individual. Although the reduction may not appear significant, the change will not negatively impact how much you will receive.

Federal Income Taxes

For many beneficiaries, the increase in the monthly benefit may result in a larger tax bill. This is because the amount of tax you must pay is calculated using a combined formula. The combined formula means that the following are all added together to determine your combined taxable income:

• Interest earned
• Pension payments
• Dividends received
• Income from wages
• Taxable distributions from traditional 401(k)s and IRAs

Taxation on income from social security takes place when an individual’s combined income exceeds $25,000 and a married couple’s combined income crosses $32,000.

After reaching the above limits, up to 50% of your social security benefits become taxable until the combined income reaches $34,000 and $44,000, respectively. Once these upper thresholds have been exceeded, up to 85% of your social security benefit may be taxed.

Minimizing the Tax Burden

While the ultimate amount of tax paid on your social security benefits may not be huge, no one wants to pay more tax than they must. Therefore, reducing your tax burden means strategically taking income from the most tax-efficient accounts. Determining the best approach is a complicated process and one best addressed with the help of a tax professional.