You may be aware that Social Security can be taxable, but did you know that federal income tax might be just part of what you have to pay? There are a dozen states that have their own tax on Social Security income in addition to this.
In this article, we'll take a look at how Social Security benefits can be taxed by the IRS, which states have their own Social Security benefit tax structure, and why it's important to understand how taxes on your retirement benefits work.
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Social Security can be taxable for many retirees
On the federal level, Social Security income can be taxable if your income is greater than a certain amount. To determine whether your benefits will be subject to tax, the IRS uses a figure called your "combined income," which consists of your taxable income, tax-exempt interest, and half of your Social Security benefit.
If you're single and your combined income is less than $25,000, your Social Security benefit will be tax-free. On the other hand, combined income greater than $25,000 makes as much as 50% of your benefit taxable, and if it exceeds $34,000, as much as 85% of your Social Security income can be subject to federal income tax. If you're married filing a joint return, the income thresholds are $32,000 and $44,000, respectively.
The short summary is that if Social Security is essentially your only source of retirement income, you likely won't have to pay any tax on your benefits. But if you have a Social Security check, pensions, and/or taxable withdrawals from a 401(k) or other retirement account, there's a good chance that your income will be above the taxability threshold, and some of your benefits will be considered taxable income. In all, a little more than half of all Social Security beneficiaries will have to pay tax on some of their retirement benefits.
12 states have their own Social Security tax
I won't keep you in suspense. There are a dozen states that tax Social Security benefits as of 2022, and here's the list in alphabetical order:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
All of these states have their own methodology when it comes to the taxation of benefits, and just like with federal tax law, not all residents will end up paying tax on their Social Security income. And the good news is that in most cases, the income thresholds above which benefits become taxable are significantly higher than the federal government's. Just to name a couple of examples, both Connecticut and Kansas only tax Social Security benefits for residents who earn $75,000 or more.
We won't go through each individual state and its Social Security tax law here. But if you're a resident of one of these states, it's certainly a good idea to familiarize yourself with how Social Security and other retirement income is taxed before you claim your benefits.
How it could affect your retirement
You may have heard the saying, "It's not how much you make; it's how much you keep." And this is especially true in retirement. The general goal for a financially secure retirement is to generate enough income from all sources (retirement accounts, pensions, Social Security, etc.) that your living expenses will be comfortably covered.
For this reason, it's important to have as accurate of a picture as possible when it comes to the income you can expect from Social Security. While it's typically not worth moving to another state just because your retirement income is taxable, it's certainly one important piece of the puzzle to consider in your retirement planning.
