The Average Social Security Benefit Keeps Growing - Here's Why That Could Backfire

It's important to structure your retirement plan so you have income other than Social Security to fall back on. But even with a nice amount of money saved, you may find that you need your Social Security benefits to cover your living costs.

One nice thing about Social Security benefits is that they have inflation protection. Each year, benefits are eligible for a cost-of-living adjustment, or COLA, so that those monthly payments are able to keep up with rising costs.

Social Security COLAs are a good thing in theory, but those annual raises, combined with a decades-old rule, could put you at risk of losing a portion of your monthly checks.

Social Security benefits are subject to taxes

The way to earn Social Security benefits in retirement is to pay taxes on wages during your working years. For this reason, you'd think those benefits would be yours to enjoy tax-free. But that generally only applies to retirees with very low incomes.

Social Security benefits are subject to taxes based on provisional income, which is calculated as adjusted gross income plus tax-exempt income plus 50% of your annual Social Security checks. If the total is between $25,000 and $34,000 and you're single, or between $32,000 and $44,000 and you're married, you could face taxes on up to 50% of your Social Security benefits.

Meanwhile, if you're single with a provisional income of over $34,000, you could face taxes on up to 85% of your Social Security benefits. The same holds true if you're married with a provisional income above $44,000.

The provisional income thresholds don't get adjusted for inflation

You might think that only a small subset of seniors have to pay taxes on their Social Security benefits. And currently, that's true.

Thanks to the $6,000 senior tax deduction contained in the One Big Beautiful Bill Act, an estimated 88% of Social Security recipients do not owe taxes on their monthly benefits right now. But that $6,000 deduction is only temporary, and it's set to expire in 2028.

Once that happens, more seniors could end up owing taxes on their Social Security benefits. And it's not just because of the deduction disappearing.

A mismatched system hurts beneficiaries

Even without accounting for the phasing out of the $6,000 senior tax deduction, the reason more seniors are apt to eventually owe taxes on their Social Security is that those benefits adjust upward for inflation, but the provisional income thresholds do not.

The thresholds for provisional income were set back in 1983. The Social Security Administration reports that since 1984, the share of recipients whose benefits are taxed has risen from less than 10% to more than 50%.

Now, this projection does not account for the temporary reprieve provided by the $6,000 senior tax deduction. But all told, over time, more seniors are likely to lose some of their benefits to taxes if lawmakers do not make an adjustment to the provisional income formula. And they may not be motivated to do that for one big reason: Taxes on Social Security benefits serve as revenue for the program.

As it is, Social Security is facing a major funding shortfall. The program may have to cut benefits in roughly six years if lawmakers don't find a way to improve its cash flow. So Congress may not be in a rush to increase the provisional income thresholds and let more seniors off the hook.

Don't get caught off guard by a surprise tax bill

Taxes are an important thing to plan for in retirement. And you should be aware that even if you aren't subject to taxes on your Social Security benefits today, that could change in the future.

The last thing you want is a tax surprise. So it's important to understand how the rules work and when those taxes might apply.

If you're still in the process of planning for retirement, you should know that certain actions on your part could lower your chances of having to pay taxes on your Social Security benefits. Keeping your savings in a Roth IRA or 401(k), for example, could help you avoid those taxes.

Roth account withdrawals do not count toward your adjusted gross income and therefore are not part of the provisional income formula. If you're planning to withdraw $30,000 a year from your savings, taking that money from a traditional retirement account will likely put you over the limit where your benefits are subject to taxes. Withdrawing from a Roth could help you avoid those taxes entirely.

Bottom line

Social Security is one of the most important benefits for seniors. And even if you have decent retirement savings, you may be counting on those monthly checks to cover your costs.

But you should know that Social Security benefits are subject to federal income taxes, and that the thresholds at which those taxes apply are very low. Even if you're not paying taxes on those benefits now, as they continue to increase, you may find that you're eventually forced to hand a chunk of that money over to the government. The more prepared you are for that, the less of a blow it might deal your finances.