Retirees Rejoice: Social Security COLA Adjustment of 8.7% in 2023, but Beware of the Hidden Tax Trap

Retirees who rely on Social Security benefits will receive some relief from record high inflation with an 8.7% cost-of-living adjustment in 2023, but the size of Medicare Part B premiums and taxes on benefits may offset the increase. The standard monthly premium for Medicare Part B will decrease by 3% next year, making it possible for more beneficiaries to see the bump from the cost-of-living adjustment. However, the higher cost-of-living adjustment could lead to some beneficiaries being bumped into a higher tax bracket, according to a report by CNBC on October 20, 2022.

Social Security benefits are calculated by adding nontaxable interest and half of your Social Security benefits to your adjusted gross income, which is referred to as “combined” or “provisional” income. Taxes on Social Security benefits apply to single taxpayers earning $25,000 or more in combined income and married taxpayers earning $32,000 or more. The thresholds for taxes on benefits have not been adjusted for wage growth or inflation, resulting in more Social Security beneficiaries paying taxes on their benefits over time, as per a report by CNBC on January 20, 2023.

Increases in Social Security income in 2023 may result in tax consequences for beneficiaries when increasing their retirement withdrawals. Beneficiaries should consult a financial advisor to understand the impact of taxes on their Social Security benefits and plan accordingly. It is important for retirees to understand the potential impact on their Social Security benefits and plan for the potential tax consequences of record-high inflation. However, there may be room for some beneficiaries to increase their retirement withdrawals without incurring a tax liability on their benefits.