A Quiet Rule Is Shrinking Millions of Social Security Checks - And It Hasn't Changed Since 1984

No matter what your retirement plans look like, there's a strong chance Social Security will become an important income stream for you. Even if you manage to build a retirement nest egg, your money could run out over time, whereas Social Security is guaranteed to pay benefits for life. So it's important to know what to expect from those monthly checks.

You can get an estimate of your future Social Security benefit by creating an account at SSA.gov and checking your earnings statements. But the number you see on screen may not be the number you get to keep.

Thanks to a long-standing rule, Social Security benefits are subject to taxes, and that's unlikely to change anytime soon for one big reason.

How taxes on Social Security benefits work

You might assume that once you're eligible to collect Social Security, those benefits will be yours to keep in full. But you may owe federal taxes on your Social Security if your provisional income is too high.

Provisional income is calculated as 50% of your annual Social Security benefit plus tax-exempt interest income you collect and your adjusted gross income (AGI). If your provisional income stays below $25,000 as a single tax-filer or $32,000 as a joint filer, your Social Security benefits will not be taxed.

If your provisional income is between $25,000 and $34,000 and you're single, you could face taxes on up to 50% of your Social Security benefits. If your provisional income is between $32,000 and $44,000 and you're married filing jointly, up to 50% of your Social Security benefits could be taxed as well.

Then, if your provisional income exceeds $34,000 as a single tax-filer or $44,000 as a married couple filing jointly, you could face taxes on up to 85% of your Social Security benefits.

How the new $6,000 senior tax deduction fits in

You may have heard that the $6,000 senior tax deduction in the One Big Beautiful Bill Act got rid of taxes on Social Security benefits. But that's not true.

The $6,000 deduction allows eligible seniors to reduce their AGI by $6,000. AGI is part of the provisional income formula above.

By reducing AGI, many seniors are currently exempt from paying taxes on their Social Security. But that's not the same thing as having taxes on Social Security benefits go away.

Furthermore, the $6,000 deduction phases out for seniors with higher incomes, so some Social Security recipients may owe taxes on their benefits now. And the $6,000 deduction is also set to expire after the 2028 tax year. This means that come 2029, more people could see their Social Security benefits taxed.

Seniors are likely to owe taxes on Social Security in the future

The fact that the $6,000 senior tax deduction has an expiration date isn't the only reason why more Social Security recipients could owe money on their benefits in the future. It's also due to the fact that Social Security benefits, which are part of the provisional income formula, get an annual cost-of-living adjustment (COLA) to account for inflation. But the provisional income formula that was established decades ago was not designed to adjust for inflation.

That formula took effect in 1984. But over the past 42 years, Social Security benefits have risen, and they'll likely continue to rise as COLAs are applied year after year. If Congress doesn't adjust the provisional income formula for inflation, a growing number of seniors could face taxes on benefits.

That's not necessarily a bad thing, since Social Security uses those taxes as revenue. But it is something current and future retirees need to plan for, since it's likely to impact a growing percentage of seniors over time.

In 1983, when the provisional income thresholds were first established, about 8% of Social Security recipients had to pay taxes on their benefits. By 1993, an estimated 20% of recipients had their benefits taxed. The Congressional Budget Office found that as of 2014, 49% of Social Security recipients were paying taxes on their benefits.

How to avoid having your benefits taxed

Taxes on your Social Security could leave you with a smaller net benefit. 

Let's say you collect $2,500 a month in Social Security and 85% of your benefits are subject to taxes. Let's also say you're in the 22% tax bracket. If you have to pay taxes at a rate of 22% on 85% of $2,500, that means you're losing about $468 of your Social Security checks to the IRS.

That's why it's helpful to do what you can to avoid having your benefits taxed. And one strategy is to choose a Roth IRA or 401(k) for your retirement savings instead of a traditional IRA or 401(k).

Withdrawals taken from a Roth account are not considered taxable income. They don't get added to AGI and therefore don't count in calculating provisional income. But traditional IRA and 401(k) withdrawals are part of AGI and count toward provisional income.

Traditional IRA and 401(k) withdrawals are also subject to required minimum distributions, which means that even if you don't want to withdraw from your savings, you eventually might have to. That could result in a tax bill on your Social Security benefits even if your preference is to leave your IRA or 401(k) untouched and live on less.

Bottom line

Social Security may be a financial lifeline for you in retirement. But as your benefits increase, you may find yourself owing taxes on a portion of those monthly checks.

That's why it's so important to make the right moves and strategically choose a home for your long-term savings. The right type of IRA or 401(k) could spell the difference between owing taxes on your Social Security in retirement or not.