‘Stealth Tax’ on Social Security Hurts More Retirees Each Year — How It Works

Worried senior couple using phone while sitting on sofa at home.
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Social Security payments are largely determined by how much you paid into the program through payroll taxes during your working career. You could owe personal income taxes on them if they and other income reach a certain level in retirement. And thanks to annual cost-of-living adjustments (COLAs), a growing number of Social Security recipients now owe these “stealth” taxes on their benefits, financial experts say.

Although Social Security benefits are adjusted for inflation every year through COLAs, income tax thresholds for recipients have not changed since benefits were first taxed in 1984. This means that whenever benefits are increased, more seniors are exposed to income taxes on Social Security. That’s a particular problem in 2023 thanks to the 8.7% COLA — the biggest in more than 40 years.

Each year, a greater proportion of seniors have hit the income thresholds and therefore must pay taxes on their benefits, USA Today reported.

“This is a stealth tax,” Jordan Gilberti, senior lead planner and certified financial planner at Facet, told USA Today. “Everyone knows Social Security gets taxed, but rarely do they see how it’s taxed. People’s jaws would fall to the ground.”

He’s not the only one who feels that way. David Freitag, a financial planning consultant and Social Security expert at MassMutual, also referred to it as a “stealth tax” in an April interview with CNBC.

As previously reported by GOBankingRates, individuals with provisional income above $25,000 and joint filers above $32,000 have up to 50% of their Social Security income taxed. For individuals with provisional income above $34,000 and joint filers above $44,000, up to 85% of Social Security is taxed.

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Provisional income includes your gross income, tax-free interest from bonds and other sources, and 50% of your Social Security benefits, USA Today reported. For example, if you have $50,000 in income and receive $1,500 a month from Social Security, you’ll pay taxes on 85% of your $18,000 in yearly benefits, or $15,300.

Because of historically high COLAs the past couple of years, more seniors are now subject to the 85% tax. But if the thresholds had been adjusted for inflation over the years, the original $25,000 threshold would now be around $73,000, according to The Senior Citizens League, a nonpartisan advocacy group. The $32,000 threshold for couples would be $93,200.

Critics contend that tax rules governing Social Security discriminate against older Americans who depend on the program for a big chunk of their retirement income. A survey earlier year this from The Senior Citizens League found that 58% of older taxpayers want the Social Security thresholds adjusted.

“This failure to adjust the income thresholds is negatively viewed by older taxpayers as a form of double taxation and even described as ‘ageist’ in the comments we receive,” Mary Johnson, The Senior Citizens League’s Social Security and Medicare policy analyst, said in a press release.

But getting U.S. lawmakers to fix the problem has been a major challenge — mainly because seniors have been frozen out of the process.

“When they’re considering changes to Social Security and Medicare, they’ve never, ever turned to senior constituents or advocates as individuals to sit on commissions or in on negotiations,” Johnson told USA Today. “We’ve never been invited to the table.”

In nearly a dozen states, seniors might also have to pay state taxes on their Social Security benefits in addition to federal taxes. According to USA Today, states that might tax some of your benefits include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah and Vermont.

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If you want to reduce or eliminate taxes on your Social Security income, your choices are limited. One option is to reduce your provisional income, but that’s not a good option if you need the provisional income to pay the bills and finance your lifestyle.

Beyond that, you can convert your 401(k) or traditional IRA to a Roth IRA. Roth IRA distributions don’t count as provisional income, Gilberti told USA Today, although you’ll pay tax on the conversion.

“We also recommend doing those Roth conversions, if you can, by 63 [years old], because your Medicare premium, which will be taken out of your Social Security check, depends on your income from the last two years,” Gilberti said.

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