The Hidden Tax Impact You Need to Know

Starting in 2025, Social Security beneficiaries will see a 2.5% increase in their benefits due to the annual cost-of-living adjustment (COLA). While any boost in benefits may seem beneficial, some seniors may not be as pleased with the small increase, as it could push them above the threshold for federal taxes on their benefits.

Contrary to popular belief, Social Security benefits themselves are not automatically taxed. Instead, taxes are applied to what’s known as “combined income,” which determines whether and how much of your Social Security benefits are subject to federal income tax. Most states exempt Social Security benefits from state income tax, with only a few exceptions.

What is Combined Income?

Your combined income is calculated as the sum of the following:

• Your adjusted gross income (AGI)
• Any nontaxable interest you earn (such as municipal bond interest)
• Half of your Social Security benefits

This combined income figure will determine whether or not your benefits are taxable at the federal level, and how much of them will be taxed.

Also Read – 2025 SNAP Benefits Boost: Key COLA Changes You Should Know

How Much of Your Benefits Are Taxed?

Depending on your combined income, you could end up paying taxes on up to 50% or 85% of your Social Security benefits. Here’s how the taxation breaks down:

• Up to 50% of benefits taxable:
  • Single filers with a combined income between $25,000 and $34,000
  • Joint filers with a combined income between $32,000 and $44,000
• Up to 85% of benefits taxable:
  • Single filers with a combined income over $34,000
  • Joint filers with a combined income over $44,000

Why So Many Retirees Pay Taxes on Social Security

Currently, around 40% of all Social Security recipients pay federal taxes on their benefits, with this figure rising to about 50% for retirees. This is a significant increase from when Social Security benefits were first taxed in 1984. Back then, it was expected that fewer than 10% of recipients would owe taxes on their benefits, but outdated tax rules, with no adjustments for inflation, have led to more retirees paying taxes over time.

The combined income thresholds have remained the same since 1984, meaning that more retirees are now falling into taxable ranges due to inflation and rising incomes.

Also Read – Direct Impact of Inflation on Social Security Benefits in 2025 – Everything Retirees Need to Know

Minimizing Taxes on Social Security Benefits

While taxes on Social Security benefits can be frustrating, there are ways to reduce or even eliminate the tax burden. One approach is to reduce your combined income. For example, by withdrawing slightly less from traditional retirement accounts or taxable investments, you may keep your income below the tax thresholds and avoid paying taxes on your benefits.

However, this may not always be feasible due to Required Minimum Distributions (RMDs) mandated by the IRS. In such cases, careful planning of your income withdrawals and timing can help minimize taxes. Strategies like managing tax-advantaged account withdrawals or spreading out income sources can make a significant difference in reducing the amount of taxable benefits.

By carefully managing your finances and understanding the impact of the COLA increase on your combined income, you may be able to preserve your Social Security benefits without a significant tax penalty.

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