Social Security and Taxes: Changes for 2025

Social security benefits are linked to inflation, and with inflation largely under control, the large cost-of-living (COLA) increases of the last several years are now a thing of the past. This year’s increase was much smaller, and there are several other changes retirees need to think about as well.

While even a small amount of extra money every month is welcome, there are other implications. The retiree's "paycheck” usually depends on income from several sources: social security, pensions, tax-deferred retirement accounts such as 401(k)s and IRAs, taxable accounts and interest-bearing savings accounts, and other interest-bearing investments.

If you are planning to retire in 2025, you’ll get to take advantage of a bump in the maximum benefit.

It's critical to ensure your retirement income is subject to the least amount of taxes possible. Since up to 85% of social security benefits are taxable, it's essential to look at your entire financial picture from a tax perspective.

What’s Happening with Social Security Benefits?

The COLA for 2025 is 2.5%, which translates to an average increase of about $50 per month. The average check will increase from $1,927 to $1,976. The maximum benefit is also set to increase. If you retire at full retirement age (FRA), the maximum amount goes up to $4,018 in 2025, from $3,822 in 2024.

If you file an individual tax return and have combined income between $25,000 and $34,000, you may have to pay tax on up to 50% of your benefits. If you exceed $34,000, up to 85% of your benefits may be taxable.

If you file a joint return, combined income between $32,000 and $44,000 may result in up to 50% of benefits being taxed. Over $44,000 exposes you to a potential tax of 85% of your benefits.

What Happens if You Work While in Retirement?

The monthly benefit for existing retirees is just one of the impacts of the COLA. Other parts of social security are adjusted as well.

With full retirement age (FRA) nearing 67 for many retirees, it's becoming increasingly common to retire from full-time work before you reach FRA. But many retirees take on part-time work for a variety of reasons, including personal fulfillment, a desire to stay busy, and a need to supplement income. The problem is that until you reach full retirement age, social security reduces your benefit if your income exceeds certain limits.

If you are under FRA for the entire year of 2025, $1 in benefits will be withheld for every $2 in earnings that exceed $23,400. If you reach FRA in 2025, your situation is a little more favorable. You can earn up $5,180 per month without losing your benefits, and benefits are withheld at a rate of $1 in benefits withheld for every $3 you earn over the maximum prior to reaching FRA.

Once you reach FRA, there is no impact on your benefits, no matter how much you earn.

The Sources of Your Income Are Important

The income tax brackets have also increased, but the increase is the smallest in recent year, rising only about 2.8% from the 2024 brackets as inflation has cooled. The new brackets are as follows:

10%: $0-11,925 for singles and $0-$23,850 for couples
12%: $11,926-$48,475 for singles and $23,851-$96,950 for couples
22%: $48,476-$103,350 for singles and $96,951-$206,700 for couples
24%: $103,351- $197,300 for singles and at $206,701-$394,600 for couples
32%: $197,301-$250,525 for singles, and $394,601- $501,050 for couples
35%: $250,525-$626,350 for singles, and $501,051-$751,600 for couples

This is where the tax puzzle comes into play. The key is to be proactive about tax planning. If you are in early retirement, you may consider a Roth conversion to fill up lower tax brackets. You’ll be taxed on the amounts you convert, but once invested in the Roth, the funds will grow tax-free, and you won't be taxed on future withdrawals.

But you'll need to be thoughtful and consider your entire picture. Increases in social security, combined with increases in taxable interest income (remember those I Bonds that are paying close to 10%?), along with withdrawals from tax-deferred retirement accounts, can push ordinary income higher.

It may be enough to bump you into a higher level of taxation on social security

If you're getting insurance under the Affordable Care Act with a subsidy, you'll want to be careful that income doesn't get to a level that decreases or eliminates your subsidy amount.

The Bottom Line

Cost-of-living increases in social security are permanent and can be seen as one upside of the inflationary environment we've been in for the last couple of years. But for retirees, it's important to consider each piece of your income and taxation and to understand the moves you can make to keep more money in your pocket.

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