Inflation related COLAs hit retirement contribution, other tax limits

The Consumer Price Index's reading of inflation hit a 40-year high of 9.1% in June and has only come down slightly, to 8.2%, in the latest reading for September. This inflation trend has certainly been hard on pocketbooks, but there may be some positive impacts to be found in the fact that certain government benefits and many limits in the tax code are indexed to inflation. Low inflation in the past have often left these changes off our radar because they were happening slowly. Not so for 2023. Here are some of the significant changes to note, and to plan for in the coming year.

Social Security recipients are likely already aware that their payments will be 8.7% higher starting in January. On average, this translates into a $140 monthly increase. Retirees had become used to miniscule Social Security cost of living increases which were often largely offset by increases in their Medicare Part B premiums. For 2023, these premiums are actually going down by 3% providing another small boost to retiree monthly incomes. This is the first decrease in Medicare premiums in more than ten years.

Medicare premiums can also be impacted by something called the Income Related Monthly Adjustment Amount or IRMAA. This is an additional premium that must be paid by Medicare recipients with higher incomes. Currently, the IRMAA is triggered at $91,000 of Adjusted Gross Income for a single filer and $182,000 for a married couple filing jointly. IRMAA amount increases with AGI across five income brackets, each of which is a cliff. If AGI is one dollar over the threshold, the IRMAA applies for the entire year. Because the IRMAA is based on tax returns from two years prior, it is also a bit challenging to plan for because you cannot do anything to change what your income was two years ago.

It is possible that the increase in Social Security income in 2023 could trigger IRMAA for some retirees in 2025. The good news, however, is that the IRMAA brackets are also indexed for inflation. For 2023, based on 2021 tax returns, the first IRMAA threshold starts at $97,000 of AGI for single filers and $194,000 for joint returns. By the time the 2023 Social Security COLA has an impact on IRMAA in 2025, the IRMAA brackets will be even higher from subsequent inflation-related adjustments.

Inflation will also impact the tax brackets and standard deduction for 2023 which should translate into a smaller income tax bill for all taxpayers. For married couples, the standard deduction will increase $1,800 to $27,700 ($13,850 for single filers). This 7% increase in the standard deduction will also hit the tax brackets, meaning that more income will be taxed at lower marginal rates resulting in smaller tax bills on the same amount of income. This tax reductions will not be enough to offset the negative impact of higher prices, but it will take a bit of the sting away.

Another way to cut taxes for 2023 is to make sure you are taking full advantage of retirement savings opportunities. These are also subject to limits that are indexed for inflation, so higher limits are in store for next year. For employer-sponsored retirement plans such as 401(k)s and 403(b)s, the maximum salary contribution limit is increasing to $22,500 from $19,500. Employees aged 50 and older can also make a catch-up contribution. This catch-up limit is $7,500 for 2023, up from $6,500.

The IRA contribution limit is also increased for 2023 to $6,500 from $6,000. The catch-up limit for IRAs for those aged 50 and older remains $1,000. The income limit that determines who can make contributions directly to Roth IRAs will also be higher for 2023. Single taxpayers with Modified Adjusted Gross Income of less than $138,000 a full Roth contribution is allowed. For married taxpayers, the income threshold at which Roth contribution eligibility begins to phase out is $218,000.

David T. Mayes

Columnist