Will Inflation Cause 85% of Your Social Security Income to Be Taxed?

Amid rampant inflation, Social Security payments are set to get a hefty boost. But that boon may come with a major consequence: a gnarly tax bill.

With inflation running at 8.5% after running as high as 9.1% this year compared to a year ago, people collecting Social Security retirement benefits can expect to see a tidy cost-of-living adjustment (COLA) next year. After inflation hit 7% for 2021, Social Security checks increased by 5.9%. For someone receiving the average benefit amount, that’s meant an increase of nearly $96 a month this year.

But what inflation gives, inflation may also take away.

That’s because when tax time comes, Social Security recipients who’ve increased their income to meet higher costs for gas, food, rent and more could be hit with taxes on 50% of even 85% on part of their Social Security income.

For more in-depth analysis of how a COLA increase may affect your tax liability in retirement, consider matching with an expert financial advisor. 

Will You Be Taxed Heavily Amid Social Security Increases?

The income limits are low enough that someone earning $500 a week, or someone pulling slightly more than $2,000 a month out of a retirement account, could find that his or her Social Security payments suddenly are taxable upwards of 85%.

Even worse: Since half of your Social Security benefits count toward those income limits, your inflation-adjusted monthly benefit check also could put you over the income limit.

Though retirees always want to know how much they can make without being taxed, the problem is that while many parts of the tax code automatically adjust for inflation – such as the income levels for tax brackets – the income limits at which Social Security benefits become taxable are stuck at the same dollar amounts from the year they were created – 1983 for the tax on 50% of benefits, and 1993 for the tax on 85% of benefits.

These limits apply to something the Social Security Administration calls “combined income,” which is calculated like this:

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Adjusted gross income from your federal tax return
Plus nontaxable interest income from bonds
Plus half of your Social Security benefits
Equals your “combined income.”

Adjusted gross income includes, wages, dividends, capital gains, business income, most pension income, taxable retirement account distributions. So, if you’re covering the cost of inflation by pulling more money out of a traditional IRA, 401(k), 403(b) or other taxable retirement account, or you’re bringing in more income from a job, that extra money can push your combined income above the threshold for taxable benefits. (Withdrawals from a Roth IRA aren’t included in your adjusted gross income.)

What Are the Income Limits for Social Security Taxes?

The income limits for Social Security taxes are quite low, and all the more easily reachable with Social Security payment increases.

Combined income for single filers
Income of $25,000 to $34,000 may trigger income tax on up to 50% of your benefits
Income above $34,000 may trigger income tax on up to 85% of your benefits

Combined income for joint filers
Income of $32,000 and $44,000 may trigger income tax on up to 50% of your benefits
Income above $44,000 may trigger income tax on up to 85% of your benefits

How all this shakes out for each individual or couple depends on how much the inflation-adjusted income tax brackets might lower your federal tax versus how much the static Social Security income limits increase your combined income total.

Social Security benefits weren’t taxed at all until Pres. Ronald Reagan signed the Social Security reform law of 1993. Starting in 1984, the income limit was $25,000 for single filers and $32,000 for joint filers, with only 50% of benefits subject to tax. In 1993, Pres. Bill Clinton signed the Omnibus Budget Reconciliation Act, which added the 85% taxable benefit rule, setting the limit at $34,000 for single filers and $44,000 for joint filers.

In the nearly three decades since the benefits tax was last adjusted, none of the limits have been raised.

If they had, the threshold for the tax on 50% of benefits would now be $72,600 for single filers and $93,000 for joint filers. The 85% benefit tax limit would be almost $69,000 for single filers and $89,000 for joint filers.

The original 1984 tax was expected to affect 10% of Social Security beneficiaries. For 2022, the Social Security Administration estimates that about 56% of benefit recipients will owe income taxes on their benefits.

Bottom Line

With COLA increases to Social Security payments amid rampant inflation, retirees who stand to receive larger payments and who are also increasing their withdrawals from retirement accounts to keep up with the increased cost of living could find themselves facing a hefty tax penalty. Consult with a financial advisor to see how to strategize your investments, withdrawals and taxes accordingly.

Retirement Planning Tips

• Not sure how an increase in your Social Security payments will affect you? For a solid, long-term financial plan and help potentially lowering your tax liability, consider speaking with a qualified financial advisor. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

• Use SmartAsset’s free retirement calculator can help you determine how much money you’ll need to withdraw from your retirement accounts amid the increasing cost of living.

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