The 2027 Social Security COLA Could Trigger a New Tax for Seniors Next Year

Ideally, you won't end up living on just Social Security when you retire. Rather, you'll have different income streams, whether it's dividends in an investment portfolio, withdrawals from an IRA, or earnings from a part-time job or business you choose to start.

But many people do, in fact, end up retiring on just Social Security. And for seniors in that situation, the program's annual cost-of-living adjustments, or COLAs, are extremely important, since they're what help benefits keep up with inflation.

Initial estimates are calling for a larger Social Security COLA in 2027 than the 2.8% raise retirees received earlier this year, but a more generous COLA could have unwanted tax consequences for some older Americans.

The 2027 Social Security COLA could be substantial

Social Security COLAs are tied to inflation. And if you've been paying attention to prices these past few months, you're probably aware that costs are up in a number of key categories, including gas. That's setting the stage for a larger Social Security COLA in the new year.

The Senior Citizens League updates its COLA projections every time the monthly Consumer Price Index (CPI) is released. And based on the most recent data, the group is calling for a 3.8% COLA in 2027. Meanwhile, independent Social Security analyst Mary Johnson is projecting a 3.7% COLA for 2027, which is fairly in line with the Senior Citizens League's number.

Now those estimates could change in the coming months as more inflation data becomes available. But all told, next year's Social Security COLA is likely to be larger than this year's raise.

A larger COLA could backfire

While most seniors may be hoping for a generous Social Security COLA in 2027, a larger one could hurt moderate or higher earners. That's because larger benefits could push some retirees into a higher tax bracket, causing them to owe the IRS more money. It could also push more people into owing taxes on their Social Security benefits themselves.

Social Security benefits are subject to taxes based on provisional income. Provisional income is basically the total of modified adjusted gross income plus 50% of annual Social Security benefits.

Single tax-filers with a provisional income between $25,000 and $34,000 and joint tax-filers with a provisional income between $32,000 and $44,000 can be subject to taxes on up to 50% of their Social Security benefits.

Meanwhile, single tax-filers with a provisional income greater than $34,000 and joint tax-filers with a provisional income of more than $44,000 can be subject to taxes on up to 85% of their Social Security benefits.

If the 2027 Social Security COLA is generous, it could result in more people owing taxes on benefits, since those benefits themselves are part of the provisional income formula.

An outdated system hurts Social Security recipients today

Part of the reason taxes on Social Security benefits frustrate so many people is that the provisional income thresholds were established decades ago and have not budged since. The original thresholds for provisional income were set in 1984 and then updated in 1993.

But Social Security benefits have risen through the years thanks to the program's annual COLAs. As a result, more moderate earners may now start to owe taxes on their Social Security benefits.

How to prepare for backlash if next year's COLA is large

It's too soon to know what next year's Social Security COLA will look like. But it's important to prepare for possible tax consequences resulting from a larger raise.

One thing it could pay to do is talk to a tax professional about ways to reduce your taxable income overall. Selling investments strategically and choosing the right type of retirement account are strategies that may be able to help. It's also a good idea to set aside extra money in case you end up subject to Social Security taxes.

Bottom line

Social Security is one of the most important benefits for seniors. And a larger Social Security COLA is a good thing in theory, since it might make it easier for retirees to keep up with rising costs.

But you should know that a larger COLA in 2027 could have unwanted tax consequences. So it's important to prepare now.

The Social Security Administration should be able to make an official COLA announcement in October — specifically, Oct. 14, which is when the final CPI data needed to calculate that raise should become available. 

But you don't need to wait until then to start planning for what might happen if next year's COLA pushes you into a new tax bracket or causes your benefits to be subject to taxes. Planning for those things ahead of time could help reduce financial stress and potentially result in tax savings.

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