How do the updated 2023 tax brackets affect your Social Security check?

Taxes are part of nearly everyone's life from beginning to end - and in some cases, even after that! Most people have to pay tax on income that they earn, as well as on purchases they make, and on profits that are attained on investments.

What many may not realize, though, is that Social Security retirement income benefits can also be taxable, which in turn, can reduce the amount of net spendable income you have available to put towards buying items and services you need in the future.

Less income can equate to less purchasing power, too - so when prices rise due to inflation, but your spendable income stays the same or goes down, you might have to make some difficult choices about what you can and cannot buy.

Different types of income and withdrawals may be taxed in different ways. For instance, funds that you access from traditional IRAs (individual retirement accounts) and retirement plans are usually 100% taxable. This is because the contributions usually go into the accounts pre-tax, and the growth is tax deferred.

Other income, like that from a non-qualified deferred annuity, may only be taxable on the amount that is considered gain, with the portion that represents your original principal coming out tax-free.

The IRS has adjusted its income tax brackets for 2023. For some investors and retirees, the updated 2023 tax brackets is good news, because it could allow for more income in their pockets from retirement plans and withdrawals from personal investments.

But how will this affect Social Security checks?

The answer can depend on several key factors.

Regardless of how much money you have saved for the future, the true test of financial success in retirement has much more to do with income generation. Without having a regular and reliable incoming cash flow to count on, you could spend more time in retirement worrying about depleting your assets instead of enjoying life.

But just simply generating a stream of cash or taking withdrawals still may not be enough to give you the retirement lifestyle that you are hoping for. That's because if these funds are taxable, it will reduce the amount that you are actually able to pay on your living expenses.

With that in mind, it is essential that you determine how much net spendable income you will have and then compare that to the amount you'll need for housing, food, and healthcare, along with travel, entertainment, and fun.

One place to begin is with Social Security. If you (and/or your spouse, if applicable) qualify for Social Security retirement benefits, these funds could make up a significant portion of your monthly income in the future.

According to the Social Security Administration, an average wage earner may replace approximately 40% of their pre-retirement earnings with these benefits. But if your Social Security is taxable, you will have to share a portion of it with the government. And that means less money for you.

The amount that you owe in tax each year is determined by several factors. These include:

• How much taxable income you earn
• The way you file your income tax return
• Items you can use as tax deductions and/or tax credits

Over the past decade or so, the United States has been in the midst of a historically low interest rate environment. The same holds true for income tax rates. Today (in 2022), the top federal income tax rate is 37%.

2022 Income Tax Rates and Brackets

But not all of your income is taxed at that top rate - even if you generate a substantial amount of income. In the United States, the tax system is “progressive,” or graduated, meaning that your income can be taxed at differing rates as the amount rises.

In addition, the U.S. income tax rates are based in part on your income threshold. This refers to the income level at which you begin paying income taxes. The income threshold also works in conjunction with the standard deduction, which is a specific dollar amount that can reduce your taxable income.

In 2022, the standard deduction is $12,950 for single tax filers, as well as those who are married filing jointly. The standard deduction is $25,900 for those who are married and file their taxes jointly, and $19,400 for heads of household. These standard deduction amounts will increase for the 2023 tax year.

Standard Deduction for Tax Years 2022 and 2023

Even if you have no other qualifying tax exemptions, deductions or credits, the IRS allows you to take the standard deduction, which can reduce the amount of income you must pay taxes on. As an alternative, you could instead itemize deductions on your income tax return.

For the tax year 2023, the IRS has made some changes to the income tax rates and brackets, and along with that, it also increased the income threshold for the tax brackets by thousands of dollars.

2023 Income Tax Brackets and Rates

Given the 2023 tax rate and bracket changes, those who are on a fixed income (or whose income doesn't rise from the 2022 amount), there could be some relief when it comes to income taxes. With that, could be more money to spend on the things you want and need.

Similar to a row of dominoes, having taxable income in retirement could have an effect on your other cash flow sources, too. For example, many retirees do not know that up to 85% of their Social Security retirement income benefits could be taxable.

How much these benefits are taxed depends in large part on how much taxable income you generate from other sources - such as from a traditional IRA or 401(k) plan - as well as when you claim your Social Security benefits.

Based on your specific situation, you may have to pay tax on a percent of your Social Security benefits (for tax year 2022), if you meet one of the following criteria:

• You file your federal income tax return as an individual taxpayer, and your combined income is:
  • Between $25,000 and $34,000 (if this is the case, up to 50% of your Social Security retirement benefits could be taxable)
  • More than $34,000 (in this scenario, up to 85% of your Social Security benefits may be taxable)
• You file a joint income tax return with your spouse, and you have a combined income that is:
  • Between $32,000 and $44,000 (up to 50% of your Social Security income benefits may be taxable)
  • More than $44,000 (in this case, up to 85% of your Social Security retirement income benefits may be taxable)
• You are married and you file a separate tax return.

Your combined income is equal to your adjusted gross income plus any non-taxable interest that is earned, plus one-half of your Social Security benefits.

For tax year 2023, the IRS has made some changes to income tax rates and brackets, which could impact the amount of money you have left over to spend from your Social Security benefits. But depending on your particular situation, these changes could be positive.

For instance, although the tax brackets were shifted by inflation, the 50% and 85% cutoff numbers for how much of this income is taxable did not go up. Therefore, if your income in 2023 is the same as it was in 2022, you will likely owe less in taxes.

So, as an example, if you have taxable income of $75,000 in 2022, you will owe $12,117 in income tax. If your income remains at $75,000 for tax year 2023, though, based on the updated income tax rates and brackets, you would only owe $11,807.50 in tax - which represents a positive difference of more than $300.

Based on the amount of income you generate in 2023, the difference in the amount of tax you owe could be significant from 2022 versus 2023. This is true for both single and married income tax filers.

Increased Income Threshold for Single Income Tax Filers in 2022 and 2023

Increased Income Threshold for Joint Tax Filers in 2022 and 2023

These types of adjustments are typically made every year in order to avoid “bracket creep,” which refers to an increase in one's taxable income - even when income has lost its purchasing power due to inflation.

If your income does increase, though, you might still owe the same amount - or even more - in income taxes going forward. With that in mind, you should consider taking steps to reduce the amount of tax that you owe.

In fact, careful tax planning could significantly reduce what you are required to pay - even if you generate a fairly high amount of income. Some options here could include:

• Selling investments where you will have a loss
• Continuing to contribute to a traditional IRA and/or other traditional retirement plan(s)
• Making deductible charitable contributions

Because Social Security is a major component of many retirees' incomes, it is essential to try and reduce or eliminate taxes that you pay on this retirement cash flow source, too. So, what are ways to avoid taxes on Social Security benefits?

There are several strategies that you could use for reducing - or possibly even eliminating - taxes on your Social Security retirement income benefits. These may include the following:

• Moving income-generating assets into an IRA
• Shifting growth assets into taxable accounts
• Minimizing withdrawals from your traditional IRAs and retirement plans
• Donating your required minimum distribution (RMD)
• Ensuring that you are taking your maximum capital loss
• Reducing your business income (if applicable)

Tax-reduction strategies on Social Security and other retirement income sources can benefit you by putting more money in your pocket to spend for your own personal needs. It is important to keep in mind, though, that income tax rates can change - in some cases, by quite a bit.

For instance, ever since 1913, when the U.S. Congress imposed a federal income tax, the top rate has fluctuated between just 7% and 94% - and in 49 of the past 110 years, this rate has been at 70% or higher. This tax rate can have a significant impact on how much money you actually have available to spend.

Increased Income Threshold for Joint Tax Filers in 2022 and 2023

So, as you plan to maximize your Social Security and other retirement income sources by reducing your tax obligations, it can help if you first obtain guidance from an experienced professional in this area of financial planning.