Given the various ways in which retirement resources might be taxed, a new survey finds that many retirees may be in for a surprise this year.
Nearly half of all households that receive Social Security benefits might pay taxes this year on a portion of their benefits, according to the survey by The Senior Citizens League (TSCL). “Making matters worse, the survey indicates that retired and disabled taxpayers are more uncertain than ever about their tax liability this year,” says Mary Johnson, a Social Security analyst for TSCL.
Nearly half of survey participants (51%) said they did not expect to pay taxes on their benefits. And while that percentage is in line with what they expected, Johnson adds, however, that the other half were much more conflicted than usual about whether their benefits would be taxable or not.
TSCL notes that early survey findings indicate that less than a quarter of survey participants (24%) said they would owe taxes on their benefits, versus the 47% who reported paying taxes on Social Security benefits in a survey conducted last fall after tax season.
There’s also considerable uncertainty about the potential amount of tax on Social Security benefits. About 42% of those who thought they would owe taxes on benefits thought their tax obligation would be higher than last year. Another 53%, however, said they were not sure if the amount would be higher or lower.
The Congressional Research Service estimated in 2020 that the average amount of federal income taxes owed on Social Security benefits would be about 6.6% of Social Security benefits. While the tax varies by income, households affected were expected to pay, on average, an estimated $3,211, TSCL notes in citing the CRS report.
“Even more unlike other federal income taxes, Congress has never adjusted the income thresholds that subject Social Security benefits to taxation since the tax became effective in 1984,” Johnson further observes.
The lack of adjustment has led to both a growing number of Social Security recipients who pay the tax and a growing amount of their benefit that is subject to taxation. When the tax on benefits became law, fewer than 10% of beneficiaries paid income taxes on their benefits, the organization says. In contrast, research by the Social Security Administration based on data from 2015 projected that as many as 56% of households receiving Social Security benefits will pay taxes on a portion of their benefits in coming years.
In fact, up to 85% of Social Security benefits can be included in the taxable income of recipients whose combined, provisional income exceeds the income limits. Combined income is determined by adding the adjusted gross income, plus otherwise tax-exempt income, plus 50% of Social Security benefits.
Social Security benefits are taxable for single filers with combined provisional incomes of more than $25,000 and married couples filing jointly with provisional incomes of more than $32,000. “Had these income thresholds been adjusted for inflation since 1984, the $25,000 level would today be about $68,400, and the $32,000 level would be $87,550,” says Johnson.
Moreover, Social Security Trustees estimated in their 2021 annual report that the Social Security Trust Fund will receive $34.5 billion in revenues from the taxation of Social Security benefits in 2021 and that will jump to more than $45 billion for 2022. “That big jump is primarily due to the rising number of new retirees with higher incomes and does not factor in the impacts of the 5.9% cost-of-living adjustment received in 2022 because that affects taxes paid in the 2023 tax season,” observes Johnson.
The TSCL analyst recommends that Social Security recipients remember to check the impact of this year’s 5.9% COLA on next year’s estimated tax obligation. “It may be preferable to have taxes withheld throughout the year to avoid a big bill at tax time or worse, an underpayment penalty,” says Johnson.
Further emphasizing the importance of planning for taxes in retirement and the economic considerations, a separate study by the Center for Retirement Research at Boston College released last year finds that households in the aggregate will have to pay about 6% of their income in federal and state income taxes. Of course, this liability rises significantly for those in the top quintile of the income distribution.