The biggest increase in Social Security benefits in four decades is largely a welcomed development for retirees grappling with runaway inflation. But the 8.7% bump in monthly payments next year comes with drawbacks for some seniors.
Some retirees may find they owe taxes on their benefits for the first time, while others may be saddled with higher Medicare premiums or see other government aid reduced or taken away altogether.
The higher benefits also could erode Social Security’s reserve funds faster than expected, especially if it’s coupled with a potential recession.
“The higher-than-expected COLA costs could have long term implications for Social Security solvency, and could potentially move the insolvency date, currently around 2034, forward,” Mary Johnson, a Social Security policy analyst for The Senior Citizens League, told Yahoo Money. “A recession would put additional strain on program solvency by reducing the payroll tax revenues received by the Trust Funds.”
First, the increased income could result in bigger tax bills.
The beefed-up COLA — which boosts the average retiree benefit by more than $140 per month starting in January — will push some retirees over income thresholds, which are not indexed for inflation, requiring them to pay income taxes on part of their Social Security benefit.
Up to 85% of Social Security benefits can be taxable if your income is above $25,000 (single filers), or $32,000 (joint filers).
If you file a federal tax return as an individual and your combined income – your adjusted gross income, plus nontaxable interest you have earned on investments, plus one-half of your Social Security benefits – is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. If you earn more than $34,000, up to 85% of your benefits may be taxable.
For those of you who file a joint return and have a combined income between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. If your joint income is more than $44,000, up to 85% of your benefits may be taxable.
Many retirees are facing this tax predicament this year after the 2022 COLA increase of 5.9%, according to The Senior Citizens League’s 2022 Retirement Survey. About 59% of survey participants believe they could be at risk of higher tax liability this year due, while 21% of survey participants say that until 2022, their household income was below the income thresholds.
Medicare and other assistance programs
Rising Social Security income due to COLAs can also impact Medicare costs down the road.
A jump in your income if you are a Medicare beneficiary — whether due to the COLA, earnings from employment, retirement savings, or pensions —could possibly affect what you’ll pay in Medicare premiums. If your income is higher than $97,000 (individuals) or $194,000 (joint), you will see an increase in Part B and Part D premiums.
Those who receive low-income assistance for healthcare costs could also see a reduced amount of assistance they receive through Medicare Savings programs or Medicare Extra Help, or Medicaid.
A May-June survey from the Senior Citizens League found that 39% of participants who receive low-income benefits reported their low-income assistance was reduced due to this year’s 5.9% COLA, while 15% reported they lost access to at least one assistance program.
“The most cruel irony is that a high COLA can lead to trims in income-related benefits such as SNAP and rental assistance for low-income beneficiaries,” Johnson said.
The future of Social Security
While the bigger monthly check is swell news for Social Security recipients in the near term, it also means that total benefit costs for the Social Security Trust Fund down the road will be sharply higher than anticipated.
Right now, the main Social Security trust fund is expected to pay out full benefits through 2034, according to the annual report released earlier this year.
The increase in Social Security income provided by the 2023 COLAs will permanently raise the expected lifetime Social Security benefits needed for current and for future recipients — since the annual COLA is applied to the benefit amount of those who haven’t claimed yet — meaning the reserves could run out sooner.
The problem gets worse if there are layoffs and more workers unemployed, causing funding from payroll taxes to drop. About 90% of funding for Social Security benefits comes from payroll taxes through FICA taxes on wages.
Two developments could mitigate the faster run on Social Security’s reserves.
In January, the maximum amount of earnings subject to the Social Security tax (taxable maximum) will increase to $160,200 from $147,000, which would mean more funding will come from payroll taxes. Second, if higher wages come with higher inflation, workers paying into the program will contribute more in payroll taxes to counteract the heftier benefit for Social Security recipients.
Salaries in the U.S. are projected to grow, on average, 4.3% in 2023, up from 4.1% this year, according to The Conference Board. This would be the highest jump since 2001.
“We’re not in the 2010s anymore. Across that decade of the Great Recession and gradual recovery, salary increase budgets barely exceeded 3% of total payroll,” The Conference Board Chief Economist Dana Peterson told Yahoo Money. “By contrast, the current post-pandemic U.S. jobs boom and severe labor shortages have pushed wages and salary increase budgets higher.”
Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter @kerryhannon