5 Ways that Inflation Could Affect your Paycheck In 2023
And, because inflation is so high, the IRS and other government agencies are changing many rules to account for the price increase.
For example, the IRS announced on Tuesday that it is raising its 2023 tax brackets by 7% to account for inflation, in an effort to avoid “bracket creep,” which occurs when people are pushed into higher tax brackets due to cost-of-living salary adjustments even though their standard of living hasn’t changed.
The IRS is also increasing the standard deduction by the same percentage, which will benefit the vast majority of taxpayers who take advantage of this tax break.
“Inflation adjustments to tax brackets mean that it will be more difficult for taxpayers to reach those higher brackets, and thus more income will be taxed at lower rates next year,” Tim Steffen, director of tax planning at Baird, explained in an email.
The interplay of these changes is complicated, but the end result is that low- and middle-income taxpayers may be able to reduce their taxes.
The outlook for higher-income workers is more complex due to an inflation-adjusted increase in the Social Security tax cap.
The following are five inflation-related changes that may affect your paycheck next year.
An annual raise is nice, but it may not be enough.
According to a recent Salary.com survey, employers plan to offer their employees a 4% annual raise in 2023. This is roughly in line with the average raise given to employees in 2022.
The problem is that inflation has been running at roughly twice that rate this year, with prices rising 8.2% year on year in September.
The Federal Reserve’s economists expect inflation to ease later this year and into 2023, despite the central bank’s declaration last year that the sharp rise in prices was “transitory.”
If the Fed is correct in predicting that inflation will fall to 2.8% next year, consumers will regain some purchasing power in 2023. However, inflation has remained stubbornly sticky thus far.
Tax brackets that are more generous
As previously stated, the IRS is raising the taxable income thresholds for its seven tax brackets, which range from 10% to 37%.
According to Baird’s Steffen, a married couple earning $200,000 in both 2022 and 2023 could save $900 in taxes next year as a result of the higher limits.
Increased contribution limits for retirement
The IRS announced on Friday that the 2023 contribution limits for 401(k) plans will be increased by a record $2,000 due to inflation, allowing workers to save more money in 2023.
Individuals will be able to save up to $22,500 in their 401(k)s next year, up from the current year’s limit of $20,500, according to the agency.
Other types of defined contribution plans, such as 403(b), most 457 plans, and the federal government’s Thrift Savings Plan, are also subject to the new cap.
It is the most considerable inflation adjustment since 2007 when 401(k) plans began indexing to inflation. Since the plans began instituting cost-of-living increases 15 years ago, the IRS has typically increased the contribution limit by $500 per year or maintained it at the same level.
The IRS announced that the IRA contribution limit would increase to $6,500 next year, an 8.3% increase from the current limit of $6,000.
The catch-up contribution for people over the age of 50, on the other hand, will remain at $1,000 because that rule isn’t subject to an annual inflation adjustment, according to the agency.
Raising the Social Security tax cap
To fund the program, the Social Security Administration taxes wages, but it limits the number of individual earnings that can be taxed in a calendar year. This cap is adjusted annually to reflect the national average wage index.
The taxable maximum will rise to $160,200 due to inflation, a nearly 9% increase from the current cap of $147,000. Higher earners will face a 6.2% Social Security tax on that extra $13,200 in earnings next year.
“However, the increase in the Social Security wage base will work against taxpayers because more of their wages will be subject to the 6.2% tax,” Steffen explained. “It will feel like a tax increase of over $800 for someone whose income exceeds that threshold next year.”
Putting more money aside before taxes for health care
Because of inflation adjustments, employees who have access to Flexible Spending Accounts and Health Savings Accounts will be able to save more pre-tax dollars next year.
Employees can save up to $3,050 in an FSA in 2023, a 7% increase over the current tax year’s cap of $2,850.
Meanwhile, single workers can save up to $3,850 in an HSA next year, a 5.5% increase from 2022, and families can save up to $7,750, a 6.2% increase.
This could result in additional tax savings, but the funds must be used for healthcare expenses