It's pretty fair to say that, without Social Security, most seniors would be in deep trouble come retirement. Data from the Social Security Administration (SSA) has shown that a tad over three in five seniors relies on Social Security to account for half of their monthly income. Mind you, the average retired worker is netting just $16,300 annually, which provides pretty substantive evidence that the poor saving habits of seniors has led to their reliance on Social Security.
But this financial lifeline isn't in the best of health. According to estimates from the Social Security Board of Trustees 2016 report, seniors' critical source of retirement income could be facing up to a 21% cut within the next two decades. The Trustees specifically estimate that the Trust will begin paying out more in benefits than it brings in via revenue beginning in 2020, leading to the depletion of more than $2.8 trillion in spare cash by 2034. The prospect of a major cut in future benefits is worrisome for both new retirees and working Americans who'll retire in a few decades, and those who haven't saved much for retirement.
Surprise! Uncle Sam may want you to hand back some of your Social Security benefits
Yet the prospect of a cut in Social Security benefits is far from the only surprise seniors may encounter during retirement.
One misconception that fools a number of working Americans, and even seniors, is the fact that Social Security benefits are indeed taxable at the federal level. Passed along with the 1983 Amendments, individuals earning more than $25,000 annually and couples filing jointly with more than $32,000 in annual income are subject to having at least 50% of their Social Security benefits exposed to federal ordinary income tax. While it may not result in seniors paying a lot to Uncle Sam, it's nonetheless money that low- and middle-income seniors could probably use during their golden years.
When the federal taxation of benefits was introduced in 1983, only around 10% of all households with seniors were impacted. By 2015, per The Senior Citizens League, 56% of households were expected to pay tax on their Social Security benefits. The reason for this spike? The aforementioned $25,000 and $32,000 respective income thresholds haven't been adjusted since the 1983 Amendments were passed. That's 34 years without any adjustment for inflation!
In 2015, based on data from the SSA, the taxation of benefits generated about $31 billion in revenue for the program, or 3.4% of the $920 billion collected.
But taxation doesn't end at the federal level.
These states can tax your Social Security benefits, too
Though 37 states want absolutely nothing to do with seniors' Social Security benefits, there are 13 states that do tax Social Security benefits, to some varying degree. Four of these states -- Minnesota, North Dakota, Vermont, and West Virginia -- have adjusted-gross-income limits that mirror that of the federal government, making them among the least friendly states for Social Security recipients.
The remaining nine states that also tax Social Security benefits are:
- New Mexico
- Rhode Island
If you live in one of these 13 states, you very well may have to open up your wallet to Uncle Sam and your state government. That's not an optimal scenario for retirees.
Four states that tax Social Security where you're liable to get a free pass
However, four of these states are not like the rest. Four of these 13 states with a Social Security tax have reasonably high income thresholds that will likely give a majority of Social Security recipients a free pass.
Of the 13 states to tax Social Security benefits, Missouri has the highest adjusted gross income (AGI) exemption level. According to data culled by Kiplinger.com, individuals earning up to $85,000 in AGI and married couples filing jointly with up to $100,000 in AGI, are exempted from having their Social Security benefits taxed. What's more, even Missourians who exceed these limits may qualify for a partial exemption. Long story short, most seniors who retire in Missouri will escape the state tax on benefits.
2. Rhode Island
Coming in a very close second in terms of healthy income exemptions is Rhode Island. Individuals in Rhode Island can earn up to $80,000 in AGI, and couples filing jointly can earn up to $100,000 in AGI and still be exempted from state taxation of Social Security benefits. Like Missouri, retirees in Rhode Island are probably going to avoid the state tax on Social Security income.
The Sunflower State also has a pretty generous Social Security income exemption for retirees, albeit it takes a backseat to Missouri and Rhode Island. According to Kiplinger.com, persons with AGIs under $75,000 are exempted from paying state tax on their benefits, meaning most seniors should get a free pass.
Lastly, a majority of retirees in Connecticut, the Constitution State, are liable to skip paying tax on their Social Security benefits. Individuals who earn less than $50,000 in AGI and couples filing jointly with less than $60,000 in AGI won't owe a penny in state tax because of their Social Security income.
Where you retire can certainly have an impact on your pocketbook, and choosing one of the 13 states that tax Social Security benefits is something for seniors to consider. However, it's important to realize that not all of the 13 taxing states are created equal, and some, like the four listed above, can still be fairly friendly to most retirees.