Core Inflation Just Hit a 3-Year High. For One Retired Couple, the Frozen Tax Thresholds Turn That Into a Stealth Tax Increase.

The couple is both around 70, retired, drawing most of their income from Social Security with modest withdrawals from a traditional IRA to cover what the monthly check does not stretch to. They read the morning economic headlines: May’s core PCE rose at a 3.4% annual rate, the highest since October 2023, while headline PCE ran at 4.1%, the highest since April of that same year. The Commerce Department’s Bureau of Economic Analysis publishes that report, and PCE is the Federal Reserve’s preferred inflation gauge.

They feel the prices at the grocery store and the pharmacy, and they know what a hot inflation reading usually means: a larger cost-of-living raise on next year’s Social Security check. Retirees in online forums describe the same bittersweet feeling, relieved that a bigger raise may be coming and uneasy that it never seems to keep pace with what they actually spend. Fed Chair Warsh recently reinforced a commitment to deliver price stability and signaled a possible rate hike as soon as September, with energy prices tied to the Iran war seeping into healthcare and utilities.

One clarification matters before the rest of the story. PCE does not set the Social Security cost-of-living adjustment (COLA). The COLA is calculated by the Social Security Administration (SSA) from the CPI-W, a separate index published by the Bureau of Labor Statistics, using the third-quarter average. A hot PCE print signals that inflation is running warm, which historically points toward a heavier COLA, but it is not the formula itself.

Why a raise can cost more than it gives

Here is the catch. The IRS uses a number called provisional income to decide how much of a Social Security benefit is taxable. The formula is adjusted gross income (AGI) plus tax-exempt interest plus half of Social Security. For a married couple filing jointly, once provisional income tops $32,000, up to 50% of benefits become taxable. Above $44,000, up to 85% of benefits become taxable. For single filers, the lines are $25,000 and $34,000.

Those thresholds were set in 1984 and have never been indexed to inflation. Every other major tax figure, including the standard deduction, IRA contribution limits, and tax brackets, gets bumped up each year. These four numbers do not move. When a COLA lifts the benefit and an IRA withdrawal lifts AGI alongside it, more of the benefit slides above $32,000 and then above $44,000. A larger nominal check is taxed more heavily, even when real buying power has not improved. Inflation does the work that a tax-law change usually would, without a single vote in Congress.

The 85% figure represents the share of the benefit that becomes taxable, with ordinary income tax rates applied to that portion. The original 1984 law targeted higher-income retirees. Four decades of inflation have pulled the line down to ordinary middle-income households, while retirees below the thresholds owe no federal tax on benefits.

Where IRA timing enters the picture

For this couple, the biggest lever is the IRA. Traditional IRA withdrawals count toward provisional income dollar for dollar. Roth withdrawals do not. Neither does principal pulled from a taxable brokerage account. The order in which retirement money is tapped, and the year it is tapped, changes how much of the Social Security check ends up taxed. Once provisional income crosses the first threshold, up to 50% of the benefit becomes taxable; above the second, up to 85% becomes taxable.

Required minimum distributions (RMDs) add another wrinkle. At age 73 under current rules, withdrawals from traditional accounts become mandatory, and those forced distributions can push provisional income over the second threshold whether the cash is needed or not. A small Roth conversion in a lower-income year, done carefully, can shrink that future RMD and the tax bite that travels with it.

What the couple can actually control

Two questions are worth thinking through before the next tax year closes:

1. How withdrawals are sequenced. Pulling from a Roth or taxable account in a year when other income is already near a threshold can keep more of the Social Security benefit out of the taxable column. Pulling a little extra from a traditional IRA in a lower-income year can use up room before the next threshold kicks in.
2. Whether a partial Roth conversion makes sense now. Paying tax on a slice of the traditional balance today, at a known rate, may beat letting future RMDs and a frozen threshold decide later.

The frozen thresholds reflect a policy quirk of the 1984 law. The hardest mistake to undo is a large, unplanned traditional withdrawal that lands in the same year as a strong COLA, because the tax ripples through the return after the money is already spent. A conversation with a tax preparer who has run these numbers for retirees is usually worth more than it costs. Every household’s mix of income, deductions, and timing is different, and small shifts can change the result.

Contact [email protected] for any questions or corrections.