As the new year dawns, millions of Social Security beneficiaries will start to see a 2.5% cost-of-living adjustment, or COLA, translating into an average increase of about $50 per month. That change, designed to help retirees keep up with inflation, comes with a warning: Because of recent legislative changes and adjustments in income thresholds, some of these beneficiaries will find themselves paying more in taxes come 2025.
Key changes affecting beneficiaries
The recently enacted Social Security Fairness Act repealed two major provisions: the Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO), which had been reducing benefits for many public sector employees receiving pensions. The change in the law is projected to increase monthly Social Security payments for an estimated 3 million individuals, including teachers, firefighters, and police officers. However, the increased benefit amount may also cause some beneficiaries to be pushed into a higher tax bracket, leading to increased federal income tax liabilities.
Today, about 40% of Social Security recipients pay federal income tax on their benefits. With the added payments, courtesy of the Social Security Fairness Act, more of that will now be subject to tax payments. Under current tax law, single filers whose joint income is between $25,000 and $34,000 pay tax on up to 50% of their benefits; above $34,000, up to 85% of the benefit is taxable. For married couples filing jointly, the levels are $32,000 and $44,000, respectively.
Impact on upper earners
On top of the changes stemming from the Social Security Fairness Act, the taxable maximum income subject to Social Security taxes will rise from $168,600 in 2024 to $176,100 in 2025. That’s a bump in the contribution amount that will force higher earners to contribute more through Social Security taxes based on wages. Because of that, those in lower tax brackets might be in a higher tax situation as overall income would be augmented because of more payments for Social Security.
Those changes are prompting financial advisers to urge beneficiaries to reassess their tax situations. “Beneficiaries should look into ways to reduce their potential tax burden,” says Kevin Thompson, chief executive of 9i Capital Group. That may involve withholding adjustments or conversions of pretax retirement accounts to Roth IRAs to reduce future taxable income.
A mixed bag for beneficiaries
While the COLA adjustment brings welcome relief to many retirees and people with disabilities relying on their Social Security checks, the complication of possible taxation wipes out a portion of that good news. The cost of the new law will be about $196 billion over the next decade, the Congressional Budget Office estimated.
Experts note that those formerly taxed at the 50% rate might find they are now paying 85% in tax rates since amounts for benefits have gone up. That change can occur when a spouse passes away and alters a widows’ or widowers’ status.
Looking ahead
As we enter the midpoint of 2025, it is more important than ever for beneficiaries to stay up to speed on these kinds of changes and their consequences. The changes in both benefits and tax obligations illustrate just how critical financial planning and awareness are for retirees and near-retirees.
Read more: Here’s why Dec. 31 is the most important day for Security payments with the COLA adjustment in 2025
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