This Social Security Tax Rule Is Costing Retirees More Each Year

Many retirees assume Social Security benefits are tax-free in retirement. Discovering that you owe taxes on Social Security benefits when filing your tax returns leads to a rude surprise for millions of people each year.

Thanks to rising incomes, cost-of-living adjustments on Social Security benefits, and required minimum distributions from retirement accounts, more retirees now owe federal income taxes on their Social Security benefits than ever before. Learn how Social Security income taxes are calculated and what factors lead to you owing taxes on your retirement benefits, so you can avoid wasting money in retirement.

Why more retirees are paying taxes on Social Security

When Social Security was first taxed in the 1980s, only a small percentage of higher-income retirees were affected. Today, a much larger share of retirees owe taxes on at least part of their benefits.

While this may seem confusing to some retirees, the answer is simple. When Congress passed the law taxing Social Security benefits, the income thresholds that determine whether your Social Security benefits are taxable have never been adjusted for inflation. Inflation adjustments are typically small from year to year, but they add up over time. Suddenly, a huge portion of retirees are paying taxes on Social Security benefits, even though the intention was to tax seniors with higher incomes.

How Social Security benefits are taxed at the federal level

Social Security income taxes are based on a taxpayer's income and filing status. The combined income includes your adjusted gross income (AGI), nontaxable interest, and one-half of your Social Security benefits. Based on that total, up to 85% of your Social Security benefits are taxable.

For single filers (including heads of household and qualifying widows or widowers):

• Below $25,000: benefits are not taxable
• $25,000 to $34,000: up to 50% of benefits may be taxable
• Above $34,000: up to 85% of benefits may be taxable

For married couples filing jointly:

• Below $32,000: benefits are not taxable
• $32,000 to $44,000: up to 50% of benefits may be taxable
• Above $44,000: up to 85% of benefits may be taxable

For married couples filing separately and living apart:

• Below $25,000: benefits are not taxable
• $32,000 to $44,000: up to 50% of benefits may be taxable
• Above $44,000: up to 85% of benefits may be taxable

If you are married and filing separately, but lived together at any time during the year, your benefits are taxable up to 50%, even if your other income is zero.

The real problem: these thresholds never move

Here's the catch with the income limits that determine whether or not you pay taxes on Social Security benefits. Those income limits were set decades ago and are not indexed for inflation.

That means:

• Cost-of-living adjustments (COLAs) increase your Social Security benefit
• Pension income may rise
• Required minimum distributions (RMDs) from retirement accounts increase with age
• Modest part-time work or investment income can push you over a threshold

Many seniors start retirement under the income threshold, but over time, more and more of their Social Security benefits are subject to income taxes, even when their lifestyle hasn't changed.

A simple example of how retirees get caught

Imagine you retire at 66 with:

• $20,000 per year in Social Security
• $12,000 from a small pension
• $2,000 from savings interest

Your combined income might fall below the taxation threshold in your first year of retirement. This means that your Social Security benefits aren't taxed. However, your income will grow as Social Security income receives cost-of-living adjustments and IRS-required minimum distributions from retirement plans increase as you age.

After a few years of retirement:

• COLAs raise your Social Security to $23,000
• RMDs from your IRA add $6,000 of income
• Interest income remains steady

Without realizing it, your combined income now crosses the threshold. Suddenly, up to 50% of your Social Security benefits become taxable. As RMDs from retirement accounts increase with age and COLAs boost your Social Security checks, suddenly you'll be paying taxes on 85% of your Social Security benefits.

Your retirement portfolio hasn't changed in a meaningful way, and you aren't suddenly living a luxurious lifestyle. Yet, now you're paying taxes on a higher percentage of your benefits.

Why this issue keeps getting worse every year

This tax rule affects more retirees annually because:

• Social Security benefits rise with inflation
• Retirement account withdrawals grow over time
• The thresholds remain frozen
• People live longer and rely on multiple income sources

As a result, many retirees see higher tax bills even when their financial situation hasn't changed.

One way to eliminate the shock during tax season is to request voluntary federal tax withholding from your Social Security benefits. This eliminates an unexpected tax bill and avoids underpayment penalties that the IRS may tack on to your tax bill.

Why understanding this rule matters for retirement income planning

If you assume Social Security will always be tax-free, you may overestimate your net retirement income. Taxes on benefits can reduce monthly cash flow, push you into a higher tax bracket, and affect how long your savings last. Planning for taxes on your Social Security benefits helps you set a realistic budget in retirement and avoids unpleasant surprises during tax season.

Bottom line

When planning for retirement, most seniors assume that they'll have 100% of their Social Security benefits to pay for monthly expenses. However, more and more retirees owe taxes on Social Security each year because income thresholds do not adjust for inflation.

Rising benefits, growing required minimum distributions from retirement plans, and longer retirements quietly pull more seniors into this situation over time. Knowing how the Social Security income tax rule works doesn't eliminate taxes, but it helps you plan for the tax bill and how to budget your retirement income to meet your goals.

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