How The 2025 COLA Affects Whether You Owe Taxes On Social Security Or Not

You've worked hard, retired, and now rely on Social Security checks to make ends meet. But recently, you might have noticed that your dollar doesn't stretch quite as far. Coffee prices have shot up, and grocery bills have followed suit, squeezing your budget. This is where the Cost-of-Living Adjustment or COLA, steps in as your financial lifeline in retirement, adapting as the economy zigs and zags. Every year, the Social Security Administration checks the Consumer Price Index, which tracks how much families spend and how rising prices affect them. Using this data, your Social Security checks get adjusted to keep up with inflation.

For 2025, there's a 2.5% increase on the horizon. If you're still working and haven't hit retirement age yet, you can now earn up to $23,400 before it affects your benefits. For those reaching retirement age in 2025, you can earn up to $62,160. This bump, known as the Cost-of-Living Adjustment (COLA), is a big help in uncertain economic times. It's not extra cash for fun — it's a necessary boost due to rising prices and it has been in place since late 2023. Also, note that the new rules affects you and your spouse (big changes could be coming to Social Security spousal benefits). Here's how the 2025 COLA could change your tax situation.

The Internal Revenue Service uses income thresholds to determine whether beneficiaries owe taxes on their benefits. As such, the total combined income and filing status are determinants in paying off your social security benefits tax. These thresholds are calculated based on your "provisional income," which includes half of your Social Security benefits, adjusted gross income (AGI), and any tax-exempt interest. Here is the average Social Security benefits for a retired worker by age.

The rules guiding tax thresholds as of 2024 were clear; single individuals that had combined income below $25,000 and married couples that filed jointly and had a combined income below $34,000 didn't owe any taxes on their Social Security benefits. A hypothetical example is of a single retiree receiving $1,000 monthly and accumulating a combined income of $24,500 — these individuals wouldn't pay any tax. But with the 2025 COLA law, the monthly benefit would increase to $1,025, and so their combined income edges up, potentially pushing them into a new tax bracket.

The effect of the 2.5% increase, makes it that a 50% taxation rate applies to combined incomes between $25,000 and $34,000 earned by single individuals, and an 85% rate kicks in for incomes above $34,000. Couples are expected to pay tax on 50% for combined incomes they earn and is between $32,000 and $44,000. If the combined income is above $44,000, then the taxed rate goes up to 85%.

Many retirees rely heavily on Social Security and the possible inclusion in the tax paying bracket can be an unexpected burden. However, you can manage if you plan and minimize surprises during tax season. To manage your overall income level, consider using withdrawals from Roth IRAs, which are tax-free, or reduce distributions from traditional IRAs and 401(k)s. To further checkmate your benefits from becoming taxable, you can request the Social Security Administration to withhold federal taxes from your payments.

Alternatively, avoid all issues with underpayment penalties by making estimated tax payments to the IRS. This can be done quarterly. For those that are yet to receive benefits, a purposeful delay of Social Security can increase monthly payments and over the years, it might reduce the number of taxable benefits (see the unexpected effect, on your finances, of pausing your Social Security benefits). 

The Qualified Charitable Distributions (QCDs) is effective for reducing taxable income and it also has the potential to keep your combined income below the taxable threshold. Also explore traditional IRAs as they allow you to donate directly to a charity. Since married couples filing jointly have higher income thresholds before benefits become taxable, you could possibly coordinate with your spouse and together maximize the advantages of joint filing.