How are social security benefits taxed in 2022

There are 5 significant ways Social Security will be changing in 2022. What you need to know.

By now, you have probably heard that every day 10,000 or so baby boomers are turning 65. The Coronavirus may have pushed millions of Americans to retire earlier than expected. Some of you reading this have already entered retirement. I've been helping with people's retirement planning long enough to know that many of you are likely counting the days until you reach financial freedom and can leave the full-time workforce. For many, Social Security benefits will be a significant part of their income in retirement. With that in mind, it is essential to know how Social Security will be changing for 2022.

Here are five ways that Social Security will be changing in 2022.

WHAT'S NEXT? How Will Social Security benefits change in 2022?

1) Continued Erosion of the Social Security Trust Fund

Without some significant adjustments to Social Security by Congress, the current excess Social Security trust fund revenue will be depleted by the year 2033. If this occurs, it is estimated that Social Security would only be able to pay less than 80% of the promised benefits from ongoing payroll taxes. To be clear, a 20% reduction in Social Security benefits would be disastrous and threaten to throw many American retirees into poverty.

2) Full Retirement Age for Social Security Has Increased

For Americans who are still a few years away from entering retirement, those born in 1960 or later, the full retirement age for Social Security has increased to 67. You will still be able to start taking your Social Security retirement benefits at age 62, but with reduced monthly payments.

3) Social Security Cost of Living Adjustment for 2022

High inflation seems like a good thing when it comes to your Social Security benefits. The Social Security cost-of-living adjustment (COLA) will be 5.9%. This is the largest Social Security COLA in nearly 40 years. On the flip side, this also means that things you are buying every day have cost you more over the past year. In case you didn't know, your current and future Social Security benefits may be increased each year, partially depending on inflation numbers.

Marie Reed of the Federal Savings and Loan Association sits next to a million dollars in cash. What ... [+] will the maximum Social Security benefit be in 2022?

4) Maximum Social Security Benefits Will Increase

For workers near the top of the Social Security income scale, $147,000 or more for 2022, your maximum Social Security payout will likely increase slightly in 2022. No individual at full retirement age can take home more than $3,345 per month, regardless of their pre-retirement income. This number can be increased by delaying Social Security until the age of 70. Elon Musk won't get more than this at full retirement age, neither will you.

In case you were wondering, waiting until 70 could increase your Social Security benefits quite a bit. The maximum Social Security benefit at age 70 is $4,194 per month in 2022.

5) More of Your Social Security Will Be Taxed

Yes, your Social Security benefits are taxable. The amount that is hit with taxes will depend on household income levels. Just 50% of your benefits will be taxed if your income is between $25,000 and $34,000 as an individual. That goes up to $32,000 to $44,000 for a married couple, which is another example of the marriage penalty. As you get more Social Security income, more of your benefits will be taxed.

Hopefully, everyone reading this will have more income than that to live off in retirement. If so, 85% of your Social Security benefits will be taxable. That is assuming you have an income, in retirement, of $34,000 (individual) or $44,000 as a married couple.

Whatever your current age, take a moment and register for access to your Social Security benefit estimates. Visit ssa.gov, take a few minutes, and you will be able to find more information about Social Security, and more importantly, get an estimate of what your Social Security benefits will look like in retirement.

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Death and taxes are two certainties in life, as the saying goes.

But many people may not realize their Social Security benefits they receive from the government are also subject to taxes.

The way in which those levies are applied is unique.

A recent MassMutual quiz found just 42% of 1,500 respondents near retirement were able to correctly identify whether the following statement is true or false: "Social Security retirement benefits are subject to income tax just like withdrawals from a traditional [individual retirement] account."

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The answer is false.

In fact, Social Security benefits and IRA withdrawals are not treated the same under tax rules.

There is no cap on the income you must report from an IRA. But there is a cap for Social Security benefits.

"It's not well understood," Nancy Altman, president Social Security Works, a social welfare organization, said of taxes on benefits.

How Social Security taxes work

The fact that levies are applied to benefits is "extremely unpopular," Altman said. "People hate it, but it actually makes policy sense," she said.

One key reason that it makes for good policy is that Social Security benefits and private pensions are taxed in a similar way.

When the program was created in 1935, benefits were not taxed. That began to change in 1983, when Congress changed the rules so that up to 50% of Social Security benefits could be included in taxable income, if a taxpayer's income was over certain thresholds.

More changes came in 1993, which raised the portion of certain Social Security benefits subject to taxation to 85%. That change applied to higher income beneficiaries.

The result is a complicated set of rules that still applies today.

First, the taxes are based on what is known as provisional or combined income. That includes half of your Social Security benefits plus your adjusted gross income and nontaxable interest. That means that any income from wages, interest, dividends or other taxable income is counted.

Then the 50% and 85% thresholds are applied.

Individuals with combined income between $25,000 and $34,000 will pay income tax on up to 50% of their benefits. That also goes for couples with incomes between $32,000 and $44,000.

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.

There was the intent that it would only affect high-income earners when it was first passed in 1983.

Joe Elasser

founder and president of Covisum

Those thresholds are not indexed, which means they have not been updated since they were first established by Congress.

Consequently, over time more people have become subject to taxes on their benefits.

"There was the intent that it would only affect high-income earners when it was first passed in 1983, but over time, it's reached further and further down into the middle class," said Joe Elsasser, founder and president of Covisum, a provider of Social Security claiming software.

If your income is below the thresholds, your benefits generally aren't taxed, he said. But for higher wage earners, the levies are more like a benefit cut.

The revenue from the taxes goes directly back into Social Security's trust funds.

How taxes on benefits may change

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Social Security's trust funds are running low. The federal agency last year projected they could be depleted in 2034, at which point 78% of benefits will be payable.

Lawmakers have several options to shore up the program. They can raise the retirement age. They may also raise payroll taxes.

When they do eventually consider changes, re-evaluating how benefits are taxed will also likely be on the table, according to Jason Fichtner, chief economist at the Bipartisan Policy Center.

The taxation of benefits is a kind of back door means testing that has the effect of reducing benefits for people of a certain wealth or asset level, according to Fichtner.

Congress could adjust the income levels or the percentages for higher income people, while also making it so those with lower benefits are unaffected by those changes, he suggested.

There are some key ways those changes may be executed, according to Elsasser.

Congress may replace the current two thresholds with a higher one in which 85 cents on the dollar or the whole dollar is taxable.

Additionally, they could choose to eliminate the provisional income calculation and count all income toward the thresholds.

Those kinds of adjustments may be more palatable to political leaders on both sides of the aisle compared to other options.

"Saying I'm going to reduce your benefit, that doesn't sell politically," Fichtner said. "But saying we're going to tax wealthier individuals on their benefits, that probably is more politically possible for Republicans to sign on to."

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