The Social Security Administration endeavors to address inflation through its yearly Cost-of-Living Adjustment (COLA).
However, these adjustments only sometimes keep pace with the inflation rate. For instance, in 2022, the COLA was 5.9%, but the inflation rate consistently hovered at 7% or higher throughout the year.
Inflation also influences the taxes paid by retired and working Americans.
When Social Security COLAs Lag Behind Rising Prices
Here, we delve into six ways in which inflation could impact Social Security benefits and taxes in 2024:
1. Decreased Spending Power:
- Social Security recipients have long grappled with the challenge of annual COLAs struggling to combat inflation effectively. According to research from The Senior Citizens League (TSCL), average benefits fell short of inflation by approximately $1,054 between January 2021 and December 2022. Although the recent 8.7% COLA has partially mitigated this, it has yet to close the gap fully.
- One significant issue lies in the formula used to calculate the annual COLA. Based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), this formula assumes that consumers allocate approximately 7% of their household budgets to healthcare. However, according to TSCL’s Senior Survey, most respondents reported spending at least 16% of their income on healthcare.
2. Reduced Monthly Payment Increase:
- The 2024 COLA will likely be around 3.2% given the most recent inflation data. This modest increase would raise the average monthly retiree benefit of $1,790 by approximately $57.30. This represents a substantial decline compared to the $146 moderate monthly boost seen this year. The official 2024 cost-of-living adjustment is set to be announced on October 12, coinciding with the release of the September inflation figures.
3. Potential Higher Tax Bracket:
- The 2023 COLA moved some beneficiaries into a higher tax bracket, potentially resulting in increased taxes when they file their 2023 returns next year. Taxes may be owed on a portion of Social Security benefits when combined income surpasses $25,000 for single filers or $32,000 for couples filing jointly. Combined income includes half of Social Security benefits, tax-exempt interest, and other non-Social Security elements that constitute adjusted gross income.
- Individuals with combined income above $25,000 and joint filers exceeding $32,000 may have up to 50% of their Social Security income taxed. For individuals with combined income over $34,000 and joint filers surpassing $44,000, up to 85% of Social Security income becomes subject to taxation.
- Notably, the income tax thresholds for Social Security recipients have remained unchanged since benefits were initially taxed in 1984. Consequently, whenever benefits increase, more seniors may be exposed to income taxes on their Social Security.
As retirees and Social Security beneficiaries grapple with inflation and tax implications, navigating these complex financial landscapes with informed decision-making and financial planning becomes increasingly crucial to ensuring financial security during retirement.