2025 COLA Increase Could Trigger Taxation on Social Security Benefits
The Social Security Administration has announced a 2.5% cost-of-living adjustment (COLA) for benefits in 2025. While this increase is not as large as some previous adjustments, it still brings more income to retirees. This might sound like good news, but it could have an unintended tax consequence for many people.
Social Security benefits become taxable when retirees’ combined income exceeds certain thresholds. These income limits are quite low by today’s standards, meaning that even modest increases in benefits can push some recipients into taxable territory. The thresholds, which determine if taxes apply to Social Security benefits, have not been adjusted since their inception decades ago.
How Combined Income Affects Taxation on Social Security Benefits
For 2025, whether or not you pay taxes on your Social Security benefits will depend on your combined income, calculated by adding together:
- Adjusted Gross Income (AGI)
- Non-taxable interest (such as income from municipal bonds)
- 50% of your Social Security benefits
Consider this example: A retiree with an AGI of $22,000 and municipal bond interest of $2,000 receives an annual Social Security benefit of $24,000. Their combined income would be $36,000, putting them above certain income thresholds and potentially subjecting them to taxes.
For those filing as individuals, a combined income between $25,000 and $34,000 means that up to 50% of Social Security benefits can be taxed. If combined income exceeds $34,000, up to 85% of benefits can become taxable. Married couples have a slightly higher threshold, with a combined income between $32,000 and $44,000 resulting in up to 50% taxation, and any amount above $44,000 subjecting up to 85% of benefits to taxes.
Why Social Security Tax Thresholds Have Become a Problem
These income thresholds were established long ago, and have not been adjusted for inflation or the changing cost of living. As benefits increase, many retirees find themselves inching into taxable income territory, even if they once didn’t pay taxes on their Social Security benefits. With the upcoming COLA increase in 2025, even more people may find themselves in this situation.
How to Potentially Avoid Paying Taxes on Social Security Benefits
There is a proactive step that retirees can take to reduce their combined income and potentially avoid paying taxes on Social Security: moving retirement savings into a Roth account.
Withdrawals from Roth IRAs or Roth 401(k) accounts are tax-free, so they don’t count toward combined income. Returning to the example above, if the retiree only counted non-taxable interest of $2,000 and their Social Security benefits, their combined income would be $14,000, staying well below the thresholds for taxation. In contrast, a combined income of $36,000 could mean paying taxes on up to 85% of their benefits if they’re filing individually.
Switching retirement savings to a Roth account may help some retirees reduce their taxable income and keep their Social Security benefits untouched by taxes.
Without Congressional adjustments to these income limits, more retirees will face taxes on Social Security benefits with every future COLA increase. Moving savings to a Roth account might be a valuable tool for retirees who want to keep more of their benefits, even as their cost-of-living increases.
