A growing number of Americans are facing federal income taxes on their Social Security benefits, according to recent reports. This comes as the income thresholds for taxation of benefits have remained unchanged since 1984, while wages and cost of living have increased.
Income Thresholds Unchanged While Costs Rise
As reported in Yahoo Finance, income thresholds that determine taxation of Social Security benefits have not been adjusted for inflation since 1984. At that time, Congress set thresholds at $25,000 for individuals and $32,000 for married couples filing jointly.
Today, with inflation, those thresholds would equal over $65,000 for individuals and $85,000 for couples. However, the law has remained unchanged. The result is that more middle-income retirees are now facing federal taxes on their Social Security income each year.
Up To 85% of Benefits Subject to Tax
Depending on total income, retirees may have to pay tax on up to 85% of their Social Security benefits. As total income increases beyond the original $25,000 and $32,000 thresholds, taxation applies to higher percentages of benefits:
- 50% of benefits taxed for income between $25,000 and $34,000 (individuals)
- 85% of benefits taxed for income exceeding $44,000 (individuals)
So while the income thresholds have remained fixed, even moderate wage growth and inflation over decades have pushed more seniors above those lines.
Calls For Reform Unanswered So Far
There have been calls for reform to the law on taxing Social Security benefits, as increasing numbers of middle-income retirees get pushed into taxation each year. However, as reported by Fox Business, meaningful changes have yet to materialize.
Some proposals have included:
- Adjusting income thresholds for inflation each year
- Increasing the 50% and 85% thresholds to exempt more benefits
- Basing thresholds on income less medical expenses
So far there has been little progress from Congress on any revisions to the taxation framework. Absent legislative action, experts expect the trend to continue of more Americans facing taxes on their benefits.
Social Security Payroll Tax Also A Concern
Along with federal taxation of benefits, there is also focus on the long term funding of Social Security through payroll taxes. Currently, Social Security payroll taxes apply only on earned income up to $160,200.
However, as highlighted in Fox Business, some proposals would lift or eliminate that income cap. That would result in all earned income over $160,200 also getting hit with 12.4% Social Security payroll taxes.
While increasing the funding of Social Security through higher payroll tax collection, such proposals also raised concerns about impacts on higher-income workers. Ongoing funding concerns ensure Social Security taxes will remain part of the national discussion.
10 States Also Tax Social Security
In addition to potential federal income taxes on benefits, retirees in certain states face state-level taxes on Social Security income as well. As summarized in The Motley Fool, there are currently 10 states that impose income tax on Social Security benefits:
- New Mexico
- Rhode Island
Rules and thresholds vary across these states. Retirees planning to live in or move between these states need to understand how state taxes could impact their retirement income.
Key Planning Opportunities Still Exist
Despite challenges from taxes on Social Security at both federal and state levels, key planning opportunities remain for retirees. As overviewed in USA Today:
- Tax-advantaged retirement accounts like 401(k)s and IRAs can help manage tax liability
- Some states like Florida offer retirees tax perks if they establish residence
- Fixed income investments like municipal bonds provide income exempt from federal tax
Consulting with a tax professional and financial advisor can help retirees and near-retirees make decisions to best minimize taxes on their Social Security income.
Outlook Remains Uncertain
The outlook for taxation of Social Security benefits remains uncertain heading into 2024. There is increasing recognition that more middle-income retirees getting pushed into tax liability each year needs to be addressed. However, meaningful reform has yet to take shape.
Absent legislative changes indexing thresholds to inflation or otherwise exempting more benefits, existing rules around taxation of Social Security are likely to impact a growing segment of retirees. It will remain an area of focus both for individual retirement planning and for policymakers in the coming years.
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