A bill recently introduced on Capitol Hill seeks eliminate federal taxes on Social Security benefits for retirees, and would pay for it by raising the cap on Social Security payroll taxes from $147,000 to $250,000.
The proposal, the “You Earned It, You Keep It Act,” was introduced to the House in mid-August by Rep. Angie Craig (D-MN).
“Social Security is a promise we have made to the American people—if you work hard and play by the rules, the dignity of a secure retirement will be within your reach. But taxing the very benefits American workers have earned after decades on the job diminishes our promise and threatens to undermine the financial security of retirees already struggling with rising prices,” said Rep. Craig. “Eliminating this tax will help Social Security benefits go further and ensure that American retirees have all the resources they need after a lifetime of hard work.”
The You Earned It, You Keep It Act would repeal all of the federal taxation on Social Security benefits beginning in 2023. The revenue from the current taxes goes directly back into Social Security’s trust funds.
According to non-partisan analysis cited by Craig in a statement announcing the bill, the legislation would also improve the long-term solvency of Social Security compared to current law. Projections from the Social Security Administration’s Chief Actuary, Stephen C. Goss, suggest a potential additional 25 years of solvency.
How taxes are determined now
Under current law, Social Security payments are generally taxable for those who surpass certain income thresholds. If a beneficiary’s combined income (adjusted gross income + nontaxable interest + ½ of Social Security benefits) is above $25,000 as a single filer (or $32,000 for married couples filing jointly), they are subject to federal tax on Social Security benefits.
Depending on how far a beneficiary is over the base amount, either 50% or 85% of benefits are currently taxable. For those under the base amount, Social Security benefits are not taxable. Individuals with combined income of more than $34,000, as well as couples with more than $44,000, may pay tax on up to 85% of their benefits.
In 2020, the Congressional Research Service estimated that the average amount of federal income taxes owed on Social Security benefits would be about 6.6%. While the tax varies by income, households affected were expected to pay, on average, an estimated $3,211.
In addition to federal taxes, 12 states, according to AARP, also tax some or all of their residents’ Social Security benefits: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia. State policies on taxing benefits vary widely.
When Social Security was first created in 1935, benefits were not taxed. That first changed in 1983, when Congress changed the rules to allow up to 50% of Social Security benefits to be included in taxable income, if a beneficiary’s income was over certain thresholds. In 1993, Congress raised the portion of certain Social Security benefits subject to taxation to 85%, applying to higher-income beneficiaries.
Craig says bill would fight inflation
Rep. Craig also says enactment of her proposed legislation would be a solution to help combat rising inflation for those living on fixed incomes.
High inflation has caused Social Security benefits to lose 40% of their buying power since the year 2000 according to the latest update (May 2022) of an ongoing study by The Senior Citizens League (TSCL). “That’s the deepest loss in buying power since the beginning of this study by The Senior Citizens League in 2010,” said TSCL’s Social Security policy analyst Mary Johnson, who conducted the research.
The study found that since 2000, COLAs have increased Social Security benefits by a total of 64%, yet typical senior expenses through March 2022 grew by more than double that rate—130%.
The average Social Security benefit in 2000 was $816 per month. That benefit grew to $1,336.90 by 2022 due to COLA increases. Because retiree costs are rising so much faster than the COLA, this study found that a Social Security benefit of $1,876.70 per month—or $539.80 per month more than currently paid—would be required just to maintain the same level of buying power as in 2000.
TSCL’s latest projection for the 2023 Social Security COLA stands at 9.6%, which could go up or down slightly depending on what happens with August and September Consumer Price Index data.
But the 2023 COLA will certainly be historically high. The highest ever was 1980’s 14.3% increase. This year’s 5.9% COLA increase was the biggest since 1982’s 7.4% increase.
The Social Security Administration is expected to announce the official 2023 COLA on October 13, 2022, after the release of the September Consumer Price Index data.
COLA increase could trigger taxes
While a large COLA is generally good news for seniors who rely on Social Security to help them keep pace with higher costs of living, under present law it the higher incomes will push some into a higher tax bracket—and in some instances triggering permanently higher taxes for many retirees because the income thresholds are not adjusted like ordinary tax brackets.
In fact, due to 2022’s 5.9% COLA, TSCL said tens of thousands of retirees who have not paid taxes on their benefits in the past may discover they must start doing so in 2023. And with a projected 2023 COLA of 9.6%, even more will have to begin paying taxes in 2024.
“Financial advisors will want to make sure their clients’ withholdings are set at the correct level for 2022 as well as anticipate adjustments for 2023,” TSCL’s Johnson told 401k Specialist recently. “The 5.9% COLA in 2022 will boost incomes, and clients may be withdrawing at higher rates if they are attempting to cope with inflation. This is a good time to contact clients and touch base for annual reviews and to tweak that distribution withholding.”
Craig bill faces uncertain road
While the You Earned It, You Keep It Act is on the floor, it is not expected to be brought up for a vote any time soon, and joins a number of other Social Security reform bills currently under consideration on Capitol Hill.
The bill’s prospects would be brighter should Democrats hold on to a majority in the House after the November midterm elections, but would dim considerably should Republicans take over the majority.
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