Inflation is giving lower income retirees smaller COLA increases

[Sandy & Shirley]

I did the math / spreadsheet because this is what I expected, and here are the numbers!

I [FONT=&quot]started with two individuals with a $30,000 annual SSB in 2020. One living a $1,000 a week lifestyle and the other with a $6,000 a month lifestyle. Using my Maryland tax brackets, I calculated the Other Income they would need to pay their Federal, State, and Local taxes to end up with their desired lifestyles, $52,000 and $72,000 after tax![/FONT]
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Then I performed the compounded COLA adjustments (16.6%) to raise their SSB from $30,000 to $34,980 for 2023, and to keep the number fairly round, I adjusted their desired lifestyle by 16.67%.

Note how the Lower Lifestyle individual’s Other Income had to increase by a higher percentage because the Higher Lifestyle Individual was already paying the maximum 85% SSB taxability while the Lower Lifestyle individual’s taxable SSB increased by 14.24%.

Then I followed the 1983 and 1993 legislative process and recalculated each Federal Tax Due without the taxable SSB, subtracted one tax due from the other to determine how much the IRS would be transferring back to the Social Security and Health Insurance trust funds.

The final step was to calculate all of the actual SSB everyone was getting, what they were getting from the Trust Fund minus what they were Giving Back to the Trust Fund.

Once you reach your maximum 85% taxability, you get your full COLA adjustments. While you are working your way through all of the taxable SSB steps, your COLA will be less!

This is all in the name that was determined in the 1935 legislation. Our Social Security payroll tax is deposited in the Social Security Trust fund - - - - We are TRUSTing the government with our retirement money!

 

[Gumby]

No, your Social Security COLA percentage is the same. The increasing taxation may change your net after tax dollar increase, but that's not the same thing as saying you get less of a COLA.

With minor variations, you've repeated this same complaint many, many times here. Everyone has had since 1983 (when I was 24 years old) to become accustomed to the fact that Social Security will be taxed (and since 1993 to understand that up to 85% can be taxed) depending on income. If you don't understand that now, you never will. And if you do understand it but don't like it, that's why you have representation in Congress; complain to them.

 

[Sandy & Shirley]

I believe that anyone who is planning to retire has to understand the federal tax rates that they will be facing. The actual tax laws that were passed in 1983 and 1993 were written in standard congressional “jibber jabber”. But, luckily for us, there is a group at congress.gov that translates “jibber jabber” into plain English and publishes it as government sponsored “In Focus” PDF files.

If you do a google search for “IF11397”, then follow the link to “Social Security Benefit Taxation Highlights - CRS Reports”, this is the first page of the PDF file you will get:

An actual government congressional publication, in English! And this is the highlighted paragraph from the second column, where the last sentence clearly says they are definitely taking your Social Security benefits back into the trust fund!

Yes, if your retirement is well financed and your retirement income level is high enough that you are well beyond the point of 85% taxation of your benefits, then you are well into the 22% tax bracket and you can look back over your shoulder and say that 15% of your Social Security was tax free!

But, if your retirement income is middle of lower income, in the $60K to $90K range, you are facing marginal tax rates of 40.7% and 49.95% when you take money out of your IRA, and even higher if you have a part time job and also have payroll taxes.

Yes, I say things often because I care deeply for retired hard working Americans.

 

[skyking1]

"If you do a google search for “IF11397”, then follow the link to “Social Security Benefit Taxation Highlights - CRS Reports”, this is the first page of the PDF file you will get:

An actual government congressional publication, in English! And this is the highlighted paragraph from the second column, where the last sentence clearly says they are definitely taking your Social Security benefits back into the trust fund!"

Why on earth did you bother to post all that and not quote the relevant statement?

Nobody is going to follow all your secret squirrel instructions to the treasure chest.
Post a link and a quote if you are really interested in communicating an idea.

 

[RetiredHappy]

Definitely "jibber jabber" logic being posted here. If you get the same amount of SSB, the COLA is the same, percentage as well as in $ amount.

However, if you get a smaller SSB, you get a smaller absolute amount because COLA is a percentage that is applied on the SSB.

 

[TheWizard]

Secret squirrel instructions!
Neato!!!

 

[TheWizard]

But yes, it's true that lower income people pay less income tax on their SS benefits than we higher income people.
So, now what was the question?

 

[pb4uski]

Yeah, I think OP headline of "Inflation is giving lower income retirees smaller COLA increases" is wrong. https://www.irscalculators.com/tax-calculator

It looks to me like the lower income individual ends up with a higher increase in money available to spend after taxes as a result of an increase in SS with all else held constant.

For the lower income individual the 3.2% increase in SS results in a 3.1% increase in after-tax income available for spending and for the higher income individual the same 3.2% increase in SS results in only a 2.5% increase in after-tax income available for spending.

	Lower income			Higher income
	2023	2024		2023	2024
tIRA withdrawals	25,000	25,000		53,500	53,500
SS	30,000	30,960		30,000	30,960
Taxable SS	9,600	10,008		25,500	26,316
Std deduction	-15,700	-16,450		-15,700	-16,450
Taxable income	18,900	18,558		63,300	63,366
Federal tax	2,048	1,995		9,234	8,994
MD Tax	869	290		2,223	1,643
Spending	52,083	53,675		72,043	73,823
Increase in spending		3.1%			2.5%
Increase in income		1.7%			1.1%
SS taxed	32.0%	32.3%		85.0%	85.0%

I know the OP likes to complain about SS being taxed, but there are good reasons for that being so:

The 1979 Advisory Council was charged with studying the financing and benefit provisions of the Social Security program. The Council wrote extensively on the issue of taxation of Social Security benefits:

The present tax treatment of social security was established at a time when both social security benefits and income tax rates were low. In 1941 the Bureau of Internal Revenue ruled that social security benefits were not taxable, most probably because they were viewed as a form of income similar to a gift or gratuity.

The council believes that this ruling was wrong when made and is wrong today. The right to social security benefits is derived from earnings in covered employment just as is the case with private pensions.

The council believes that the current tax treatment of private pensions is a more appropriate model for the tax treatment of social security, Pension benefits from contributory private pension plans (including those for government employees) are now taxed to the extent that the benefits exceed the employee's accumulated contributions to the plan. Cumulative retirement benefits up to the employee's own total contributions are not taxed because the income from which the contributions were paid was taxable. That part of the benefit representing the employer's contribution and interest income on both the employee's and the employer's contributions is taxed when received.

Estimates by the Office of the Actuary of the Social Security Administration indicate that workers now entering covered employment in aggregate will make payroll tax payments totaling no more than 17 percent of the benefits that they can expect to receive. The self-employed will pay no more than 26 percent on average. Therefore, if social security benefits were accorded the same tax treatment as private pensions, only 17 percent of the benefit would be exempt from tax when received, and 83 percent would be taxable. . .​

https://www.ssa.gov/history/taxationofbenefits.html

Finally, why the OP didn't just link the report rather than provide the secret squirrel instructions will remain a mystery, but here it is https://crsreports.congress.gov/product/pdf/IF/IF11397/2

 

[Out-to-Lunch]

I *think* what you are saying is:
-there is a "tax torpedo" because there are certain thresholds for taxation at 0%, 50%, and 85%.
-the taxation thresholds are NOT indexed for inflation.

Was there anything I missed?

 

[Sandy & Shirley]

During our working lives we are faced with tax rates of 10, 12, 22, 24 percent. When we are retired we face tax rates of 15, 18.5, 22.2, 40.7, then, after 85% of your SSB has become taxable, 22, 24 percent.

Once you have reached the 85% taxable SSB level and you are back into the 22 and 24 percent tax rates, all that you are saying is true.

For those who are comfortable in their lifestyle and have not reached the 40.7% marginal tax rate, that is when inflation creates larger percentages of taxable SSB which creates larger Give Back amounts which creates smaller COLAs after the Give Back.

 

[pb4uski]

Tax rates today for low and middle income people are historically low.

According to the Tax Foundation, the effective federal tax rate on the bottom 50% of taxpayers has decreased since 1990. In 1990, the effective federal tax rate for the bottom 50% of taxpayers was 8.2%. In 2022, the effective federal tax rate for the bottom 50% of taxpayers was 3.1%.

This decrease is due in part to a number of tax cuts that have been enacted since 1990, including the Tax Reform Act of 1986, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 1992, the Taxpayer Relief Act of 1997, the Economic Growth and Tax Relief Reconciliation Act of 2001, and the Tax Cuts and Jobs Act of 2017.

These tax cuts have disproportionately benefited low- and middle-income taxpayers. For example, the Tax Cuts and Jobs Act of 2017 increased the standard deduction and child tax credit, which are two of the most important tax benefits for low- and middle-income families.

As a result of these tax cuts, the effective federal tax rate on the bottom 50% of taxpayers has decreased significantly since 1990. This means that low- and middle-income taxpayers are keeping more of their hard-earned money.

 

[GrayHare]

I don't understand any of this discussion, it sounds very confused to me.

 

[Dtail]

I don't understand any of this discussion, it sounds very confused to me.

Basically, the OP is stating that at certain levels, the marginal percentage increase on one's income can be at the 40% level due to the level of Social Security being taxed at the higher 50 and 85% brackets.
So even though one is not in a 40% tax bracket, their additional income at a certain range of income can be taxed at 40%.
Once one is already taxed at 85% for SS, the marginal rates go back to the effective tax bracket rates.

 

[Gumby]

As pb4uski has noted several times before, the 85% taxation is analogous to what would happen if you had a private contributory pension funded with after tax dollars. Each payment you get in retirement would consist of about 15% return of your own prior contribution and 85% new money that has never before been taxed. For whatever reason, the government previously subsidized Social Security recipients by not taxing payments to them. However, in an effort to keep the system solvent, since 1983 the government has gradually been withdrawing that subsidy by implementing a tax and not adjusting the taxation thresholds for inflation. But lower income SS recipients are still subsidized even today.

Those of us who are taxed on the full 85% of our SS have already faced AND PAID those high marginal tax rates as SS taxation kicks in. (as well as usually having been beyond the second bend point during our working years and receiving a much lower return on our contributions). So, frankly, I am tired of hearing complaints about it. In a completely fair world, 85% of SS would be taxed from the first dollar received.

 

[pb4uski]

Basically, the OP is stating that at certain levels, the marginal percentage increase on one's income can be at the 40% level due to the level of Social Security being taxed at the higher 50 and 85% brackets.
So even though one is not in a 40% tax bracket, their additional income at a certain range of income can be taxed at 40%.
Once one is already taxed at 85% for SS, the marginal rates go back to the effective tax bracket rates.

Also, the extremely high marginal rates (22%*(1+85%)) apply for a fairly narrow amount of income... about $4,741 for a single in 2023... the OP doth protest too much methinks and needs to look at the bigger picture that lower income people get higher benefits per $ contributed and get taxed at lower tax rates overall despite the anomaly of an extremely high marginal rate for a narrow band of income... get over it.

 

[TheWizard]

I don't understand any of this discussion, it sounds very confused to me.

The OP is upset with the Social Security taxation algorithm, in which a lesser percentage of SS goes into your AGI for lower income people.

The solution, obviously, is to make 85% of SS benefits taxable for EVERYBODY.
Lower income folks already have a low tax bracket; no need to make it more complicated.

Plus, this is a step in the right direction toward alleviating the shortfall that SS is facing a decade from now...

 

[pb4uski]

.... In a completely fair world, 85% of SS would be taxed from the first dollar received.

Agreed, though since each person's SS statement indicates what they contributed, if Congress wanted to they could devise a formula to do a more precise calculation of the taxable portion of SS benefits, but I think that would be a disadvantage to lower income people since they receive higher benefits in relation to their contributions and a flat 85% would be easier administratively.

 

[target2019]

During our working lives we are faced with tax rates of 10, 12, 22, 24 percent. When we are retired we face tax rates of 15, 18.5, 22.2, 40.7, then, after 85% of your SSB has become taxable, 22, 24 percent.

Once you have reached the 85% taxable SSB level and you are back into the 22 and 24 percent tax rates, all that you are saying is true.

For those who are comfortable in their lifestyle and have not reached the 40.7% marginal tax rate, that is when inflation creates larger percentages of taxable SSB which creates larger Give Back amounts which creates smaller COLAs after the Give Back.

Sandy & Shirley,
After reading the excellent response below, I sorta understand your point.

You'll always meet resistance here when you bring up this issue. Maybe it would help you make the point by linking to articles that discuss this.

In any event, I'm embarassed when name-calling (not you) comes out in a thread.

Basically, the OP is stating that at certain levels, the marginal percentage increase on one's income can be at the 40% level due to the level of Social Security being taxed at the higher 50 and 85% brackets.
So even though one is not in a 40% tax bracket, their additional income at a certain range of income can be taxed at 40%.
Once one is already taxed at 85% for SS, the marginal rates go back to the effective tax bracket rates.

Thanks for clearing this up.

 

[Gumby]

To be clear, there is not a 50% nor an 85% tax bracket. Rather, up to 85% of your social security payment can be taxed. The actual rate of taxation on that additional income is your regular marginal rate (10%, 12%, 22%, 24%, 32%, 35%). It is just that, between certain income levels, additional income pushes more of your social security into the taxable zone as well (to be taxed at your marginal rate rather than 0%). So your effective marginal tax rate on that additional dollar is higher than you might originally think.

In my opinion, it's not hidden, it's not unfair and it's not bad public policy given the well known problems with social security.

 

[aja8888]

Reading this thread is giving me a headache.

I'm just glad I get SS after many years of working, saving and retiring with no pension and no family inheritance. I'll pay my share of taxes on the SS income along with everyone else. There's more important things in life than to worry about than stuff like SS income tax.

 

[Healthy Lifestyle]

Reading this thread is giving me a headache.

I'm just glad I get SS after many years of working, saving and retiring with no pension and no family inheritance. I'll pay my share of taxes on the SS income along with everyone else. There's more important things in life than to worry about than stuff like SS income tax.

I agree with you aj and happy that in retirement I can manage on my own and deal with these added taxes.

 

[Sandy & Shirley]

All of this depends on your personal perspective.

If your retirement lifestyle is high enough that you are already paying taxes on 85% of your Social Security, and you are in a tax free state and in the 22% Federal tax bracket: if you want to buy something for $100, you will have to withdraw $128.21 from your taxable IRA and pay 22%, $28.21 for your income tax.

If your retirement lifestyle is middle income and you are in the 22% tax bracket and 85% of your Social Security has not been taxed yet: if you want to buy something for $100, you will have to withdraw $168.63 from your taxable IRA which will also make an additional $143.34 of your SSB taxable, and pay 22% of your total taxable income of $311.97, $68.63 in federal taxes.

I am happy for those who have retirement incomes that place them well above the 85% taxation level. The real headache is being faced by those who are living below the 85% taxable SSB level. Higher income individuals can by a $100 Christmas gift for $128.21, lower income individuals might have to pay as high as $168.63 for the same gift!

 

[Gumby]

No, again. The simple fact is that the people above the 85% threshold have already paid that extra amount of tax, without even getting any gift.

 

[skyking1]

No, again. The simple fact is that the people above the 85% threshold have already paid that extra amount of tax, without even getting any gift.

Thanks Gumby. This kind of math sprouts out of the videos all over that incorrectly explains the doom and gloom.
They drag out this one dollar and then try to show you that it got taxed 3 times and 4 ways. Then that becomes the standard tinfoil calculation for all dollars.

 

[TheWizard]

A lot of us in the 22% and higher tax brackets would never withdraw additional money from tax-deferred to buy something. We already have plenty of income from sources like pensions, annuities, SS and RMDs.

In my case, for example, there's no realistic way I can lower my AGI aside from QCDs.

Computing your effective tax rate is a useful way of understanding where you stand financially. Do that by dividing your Federal Tax total by your AGI.

I'm in the upper part of the 24% bracket and my Effective Tax Rate is around 17-18%. I'm away from home and can't check my spreadsheet for 2022's exact number.

18% * 0.85 = 15.3% ETR on my gross SS income.

People going through the so-called SS Tax Hump are likely in the 12% Federal tax bracket and will have an Effective Tax Rate which is decently low, maybe 5%.
I'll run some examples later.

Point being: there are better things to complain about than having a low tax rate...