Inflation has been making every area of our lives more expensive as the costs of the goods and services we use every day have skyrocketed. The Federal Reserve is attempting to lower inflation by using the bluntest tool in its arsenal – raising the key short-term interest rate.
This has meant that as prices have continued to increase, they are being followed by higher costs for debt. If you're carrying a credit card balance, you've likely noticed the difference. And hopefully, you have a fixed-rate mortgage.
But there may be a small silver lining. The IRS pegs tax brackets, tax deductions, 401(k), and other tax-efficient vehicle contribution amounts to inflation. A careful review of your financial picture, combined with some proactive tax planning, may save you money and set you up for increased savings growth in the years to come.
Tax Brackets Are Going Up
Tax brackets are increased due to inflation to ensure that tax brackets reflect people's real income. Inflation means credits, deductions, and exemptions are worth less, which translates to an increase in taxes paid. Raising the amount of the income range in each bracket shelters more income from higher rates.
The amount of the increase is usually so small that it doesn’t affect most people’s tax brackets, but this year the brackets jumped a lot.
2022 Tax Brackets
10%: $1-10,275 for singles and $0-$20,550 for couples
12%: $10,276-$41,775 for singles and $20,551-$83,850 for couples
22%: $41,776- $89,075 for singles and $83,851-$178,150 for couples
24%: $89,076- $170,050 for singles and at $178,151-$340,100 for couples
32%: $170,051 -$215,950 for singles, and $340,101- $431,900 for couples
35%: $215,951 -$539,900 for singles, and $431,901 - $647,850 for couples
37%: $539,901 and over for singles, and $647,851 and over for couples
2023 Tax Brackets
10%: $1-11,000 for singles and $0-$22,000 for couples
12%: $11,001-$44,725 for singles and $22,001-$89,450 for couples
22%: $44,726-$95,375 for singles and $89,451-$190,750 for couples
24%: $95,376- $182,100 for singles and at $190,751-$364,200 for couples
32%: $182,101-$231,250 for singles, and $364,201- $462,500 for couples
35%: $231,251 – $578,125 for singles, and $462,501 - $693,750 for couples
37%: $578,126 and over for singles, and $693,751 and over for couples
The Standard Deduction Is Increasing
Filing your taxes may also have gotten simpler. The standard deduction – the amount you are entitled to claim without itemizing – increased to $13,850 for single files in 2023. For married couples filing jointly, the new deduction amount is $27,700. If you don’t usually itemize, this is probably good news. However, if you do itemize, you may find that some of your regular deductions, such as gifts to charity, are no longer tax benefits.
One solution is to bunch your charitable gifts. "Bunching” refers to grouping donations intended for several years into a single year. This strategy is only effective if all your itemized deductions, including the bunched gifts, are more than the standard deduction.
Retirement and Healthcare Savings Contributions
Retirement savings contributions are getting a boost of almost 10% in 2023. The new maximum contribution limit is $22,500. The "catch-up" limit for people over 50 also increased to $7,500. The new limits don't just mean increased savings; they also lower your taxable income.
Flexible health spending accounts got a $200 boost, allowing you to contribute $3,050 of pre-tax dollars to this type of account to pay for medical costs that aren’t covered by insurance.
Health Savings Accounts (HSAs) have new maximum contributions, too. An individual can contribute up to $3,850, and the family contribution has risen to $7,750. These accounts are referred to as "triple-tax-advantaged" because you contribute pre-tax dollars that lower your taxable income in the year you contribute, the accounts grow tax-free, and qualified withdrawals are also not taxed.
If you are still working and paying into Social Security your total contributions may go up. Social Security taxes are 6.2% of income, up to a maximum earnings ceiling. The limit increased by almost 9%, to $160,200 in 2023, from $147,000. This translates to a maximum dollar amount of $9,932, up from $9,114 in 2022. If you are at the top end of the income limit you may pay more Social Security tax annually.
What Happens If You Are Receiving Social Security Benefits?
Social security benefits increased as well, which may be good news for retirees. The Cost of Living Adjustment (COLA) for 2023 is 8.7%, which translates to an average increase of about $140 per month. All but 15% of social security benefits are taxable, and the percentage subject to taxes depends on your income.
If you file an individual tax return and have combined income between $25,000 and $34,000, you may have to pay tax on up to 50% of your benefits. If you exceed $34,000, up to 85% of your benefits may be taxable.
If you file a joint return, combined income between $32,000 and $44,000 may result in up to 50% of benefits being taxed. Over $44,000 exposes you to a potential tax of 85% of your benefits.
What Happens if You Work While In Retirement?
The monthly benefit for existing retirees is just one of the impacts of the COLA. Other parts of social security are adjusted as well.
With full retirement age (FRA) nearing 67 for many retirees, it's becoming increasingly common to retire from full-time work before you reach FRA. But many retirees take on part-time work for a variety of reasons, including personal fulfillment, a desire to stay busy, and a need to supplement income. The problem is that until you reach full retirement age, social security reduces your benefit if your income exceeds certain limits.
If you are under FRA for the entire year of 2023, $1 in benefits will be withheld for every $2 in earnings that exceed $21,240. If you reach FRA in 2023, $1 in benefits will be withheld for every $3 in what you earn over $56,520 prior to reaching FRA.
Once you reach FRA, there is no impact on your benefits, no matter how much you earn.
How to Plan Wisely
Elevated inflation is likely to be with us for a while longer. The Fed is working to dampen the economy to bring prices down, but a robust labor market and ongoing supply chain issues are pushing the other way. Taking advantage of the silver lining of inflation by maximizing tax-advantaged savings, and undertaking proactive tax-planning strategies, can help you keep your financial planning on track.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
This content not reviewed by FINRA