Social Security benefits are tied to inflation, and with inflation easing, the substantial cost-of-living adjustments (COLA) of recent years are tapering off. The 2025 COLA increase is smaller than in previous years, but there are still important changes that retirees need to be aware of.
Even modest increases in Social Security payments can have ripple effects across your broader retirement income strategy. Most retirees rely on multiple income sources—Social Security, pensions, tax-deferred retirement accounts like 401(k)s and IRAs, taxable investment accounts, and interest-bearing savings. Ensuring that you keep as much of this income as possible by minimizing taxes is critical.
For those retiring in 2025, there’s some good news: the maximum Social Security benefit is increasing. However, it’s essential to consider how your total income picture impacts your tax liability.
What’s Changing with Social Security Benefits?
The 2025 COLA is set at 2.5%, translating to an average monthly benefit increase of about $50. That means the average benefit will rise from $1,927 to $1,976. Additionally, the maximum monthly benefit for those retiring at full retirement age (FRA) will increase from $3,822 in 2024 to $4,018 in 2025.
When it comes to taxes, the same thresholds apply:
- If you file as an individual and your combined income is between $25,000 and $34,000, up to 50% of your benefits may be taxable. Above $34,000, that jumps to 85%.
- If you file jointly, combined income between $32,000 and $44,000 may result in 50% of your benefits being taxed, and above $44,000, up to 85% may be taxable.
What If You Work in Retirement?
Many retirees choose to work part-time before reaching FRA, whether for financial reasons or personal fulfillment. However, earning too much before FRA can temporarily reduce your Social Security benefits.
In 2025:
- If you’re under FRA for the entire year, Social Security will withhold $1 in benefits for every $2 you earn above $23,400.
- If you reach FRA in 2025, you can earn up to $5,180 per month before benefits are withheld. Above that, $1 is withheld for every $3 earned until your FRA birthday month.
- Once you reach FRA, your earnings no longer reduce your benefits.
Understanding the Tax Impact
Income tax brackets are also adjusting for 2025, though the increase is modest (about 2.8%). The new brackets are:
- 10%: $0 – $11,925 (single), $0 – $23,850 (joint)
- 12%: $11,926 – $48,475 (single), $23,851 – $96,950 (joint)
- 22%: $48,476 – $103,350 (single), $96,951 – $206,700 (joint)
- 24%: $103,351 – $197,300 (single), $206,701 – $394,600 (joint)
- 32%: $197,301 – $250,525 (single), $394,601 – $501,050 (joint)
- 35%: $250,525 – $626,350 (single), $501,051 – $751,600 (joint)
Given these brackets, tax planning is crucial. If you’re in early retirement, a Roth conversion may make sense to take advantage of lower tax rates while reducing future taxable withdrawals. However, you’ll need to be mindful of how additional income—such as higher Social Security benefits, taxable interest from investments (such as I Bonds), and required withdrawals from tax-deferred accounts—could push you into a higher tax bracket.
For those receiving health insurance subsidies under the Affordable Care Act, higher taxable income could also reduce or eliminate subsidies, so careful planning is needed.
The Bottom Line
While COLA increases are a permanent boost to Social Security benefits, they can also impact your tax situation. Taking a proactive approach to tax planning can help ensure you keep more of your retirement income. Understanding how Social Security, taxable income, and tax brackets interact will allow you to make informed decisions that maximize your after-tax cash flow in retirement.