Inflation affects everybody, but it can be a double whammy for seniors, especially those who rely heavily on Social Security for their retirement income. Not only are seniors forced to make limited dollars stretch farther as prices rise, but the amount of income tax they pay on their Social Security benefits is actually going up dramatically. As is often the case, seniors are caught in the vise between a bigger tax bite and the higher cost of just about everything.
Why should it be that the amount of taxes seniors pay on Social Security keeps on going up? As this recent article from Politico explains, one big culprit is a Social Security rule that was set in place almost 40 years ago – when Ronald Reagan was in the White House – and has never been changed. Politico reporter Brian Faler writes that many Democrats in Congress want to change the law in order to benefit seniors, but some on the Republican side of the aisle are dragging their feet.
Social Security COLA Eaten Up by Taxes, Inflation
In his Politico article, Faler writes, “Spiking inflation is helping push up taxes on a group that lawmakers are loath to cross: the elderly. While Social Security benefits increase along with rising prices, and seniors just received a fat cost-of-living adjustment, the threshold at which they can begin to owe taxes on that money is not adjusted for inflation — and hasn’t been changed since the Reagan administration.”
The problem, says Faler, is a 1984 law that requires Social Security recipients to pay income tax on their benefits when they make more than $25,000 as individuals and $32,000 for couples. Prior to 1984, benefits were not subject to federal taxes at all (a situation many believe still prevails today). When those income thresholds were set, says Politico, it only affected about 10 percent of beneficiaries. Now that figure is closer to half of all Social Security recipients.
As Incomes Rise, So Do Taxes
According to government forecasters, surging inflation is pushing more Social Security households over those 1984 limits. “It’s a big reason why the nonpartisan Congressional Budget Office sees the share of Social Security benefits subject to tax growing by 10 percent this year and another 10 percent next year,” Faler writes. “[The CBO] predicts total income taxes paid on those checks will jump this year by 37 percent.”
As Politico explains, in a contentious political environment, higher Social Security taxes “could come as a surprise to some seniors and create a headache for Democrats, already under fire over rising prices.” Many in Congress, mostly Democrats, worry about the tax bite on seniors, which has wiped out a portion of the hefty cost of living adjustment (COLA) for 2022.
One key lawmaker, Connecticut Democrat John Larson, has proposed raising the “outdated” tax thresholds of $24,000 and $36,000 (to $35,000 and $50,000 respectively). While many in Larson’s party support the move, those across the aisle are holding back, and playing the blame game against the Biden Administration.
Social Security Tax Thresholds Not Indexed for Inflation
As most people know, Social Security benefits are adjusted annually for inflation. Last January, Social Security beneficiaries received a 5.9 percent raise, the biggest in nearly 40 years. That’s the good news. The bad news, as Politico explains, is that the portion of the federal tax code which stipulates when Social Security recipients must pay taxes – Section 86 – is not indexed for inflation. “That has remained frozen in time for decades,” Faler writes — “something that was done deliberately by lawmakers, on a bipartisan basis, to shore up Social Security’s finances.”
Back in 1983, when lawmakers were debating the issue of Social Security taxes, the program was facing a major funding shortfall, says Politico. Congress and the Reagan Administration agreed to tax benefits for the first time, beginning in 1984. The rationale was two-fold: not only was the tax money raised supposed to be plowed back into the program, but the change in the law helped put Social Security on a more level playing field with private pensions, which were taxable.
As Nancy Altman, head of the advocacy group Social Security Works, told Politico, “Seniors hate it. But as a policy matter, it makes some sense.”
Originally Only High-Income Beneficiaries Had to Pay
It’s hard to realize now, but in 1984 only a small percentage of Social Security recipients were affected by the imposition of the new tax. “Lawmakers started out small,” says Politico, “applying the tax only to those with higher incomes. The $32,000 threshold for couples equals about $95,000 in today’s dollars.” As a result, only about 10 percent of beneficiaries paid taxes at first.
“But by leaving the tax unpegged to inflation, lawmakers ensured the tax would gradually hit more people and raise more money,” Fraley writes. “By 1993, when Congress expanded the levy, about 18 percent of recipients were paying at least some tax. By 2014, about half were owing.” Now, the spike in inflation is accelerating that trend.
Rising Income Equals Rising Taxes
The Politico article states that the actual calculation of income taxes on Social Security benefits “is based on a complex formula that is keyed to people’s total income, including Social Security benefits and other earnings.” But the bottom line is clear. “As incomes go up, so does the tax bite.” As an example, figures from the Joint Committee on Taxation show that, in 2020, someone making between $30,000 and $40,000 paid an average of $239 on their Social Security benefits. By contrast, says the Politico article, people in the $75,000 to $100,000 earning bracket owed an average of $1,872.
Top earners – people making more than $1 million – paid $12,129 in taxes on Social Security benefits. Last year, taxes on Social Security benefits generated $37 billion for the government, according to the Social Security and Medicare Boards of Trustees.
Many Factors Can Increase Tax Liability
One of the biggest culprits exposing Social Security beneficiaries to higher taxes was the 2022 COLA. “Because it increases people’s incomes, the cost-of-living adjustment awarded earlier this year will also increase their exposure to the tax,” Fraley writes. But there are other factors at play that can boost the tax-bite. Many private pensions are indexed to inflation, which increases household income and add to the tax burden. Seniors who decide to take higher withdrawals from retirement accounts to help soften the blow of higher prices can also find more of their Social Security benefits going back to Uncle Sam as a result.
The problem for seniors won’t get better any time soon, says Politico. “On Thursday, administration officials said inflation is proving so strong that Social Security recipients could potentially receive an 8 percent cost-of-living increase next year, though they cautioned that won’t be determined until later this year. The fraction of Social Security benefits that is crossing the taxable threshold is growing faster than overall program spending.”
Figures from the Congressional Budget Office peg Social Security spending growth at 6 percent per year for the next few years. By contrast, in 2023, the CBO estimates that almost 40 percent of total benefits will be taxable, a dollar value that’s 10 percent above 2021 figures.
There’s a Right Way to Plan, Says Rajiv
Rajiv Nagaich of AgingOptions understand full well that higher taxes and rising inflation have put a growing number of seniors in a bind. But, he said, there’s a solid solution, in the form of a planning tool called a financial dashboard. “Imagine flying an airplane without instruments,” says Rajiv. “You would never attempt it! Yet millions of people head into retirement literally flying blind when it comes to their finances. No wonder their so-called plans fall to pieces.”
Without a dashboard, unforeseen burdens like rising taxes on Social Security can catch you off guard. Instead, the financial dashboard takes into account all income, spending, and investments, and allows you (with the help of a qualified planner) to see and prepare for the impact of everything from rising taxes to inflation. You can run various “what-if” scenarios to gauge the best route to achieve your financial goals. If you’ll contact AgingOptions, we can refer you to a planner who will assist you in preparing this essential retirement planning tool.
Meanwhile, here at AgingOptions, we’ll watch this Social Security taxation story closely. For now, the old slogan apparently applies: “Uncle Sam giveth, and Uncle Sam taketh away.”
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(originally reported at www.politico.com)