Seniors rely on Social Security benefits to support them in retirement, but many of them end up paying income taxes on a portion of their Social Security income. Not only does the federal government impose taxes on Social Security for those whose incomes are above certain threshold levels, but more than a dozen states add on state-level income taxes of their own.
Recently, some local lawmakers have looked at the demographic trends that have come about as a result of their tax-policy decisions, and they're looking at changes that could provide better solutions for their residents. In particular, reducing the state-level tax burden on Social Security recipients could pay dividends in many different areas.
Vermont is where it's happening
Among the 13 states that tax Social Security benefits at least to some extent, Vermont is one of the few that offers no protection for seniors at all. Under current law, Vermont taxes Social Security income to exactly the same extent that it's taxable on federal tax returns. That means that, for single filers making more than $25,000 or joint filers with incomes above $32,000, up to half of benefits can be subject to tax. At higher thresholds of $34,000 for singles and $44,000 for joint filers, the amount included can rise to as much as 85% of Social Security income.
But Republican Governor Phil Scott recently proposed changing that. Under the governor's proposal as described in greater detail by Vermont Department of Taxes Commissioner Kaj Samsom, any single retiree with an income of $45,000 or less would be completely free of state income taxes on Social Security benefits. Those with incomes in a phase-out range of between $45,000 and $55,000 would get partial relief from Vermont income tax. Similar provisions would apply to joint filers with incomes of $65,000 or below.
In order to lessen the impact on the Vermont budget, the plan would get gradually implemented over three years. Yet even once the plan is fully in place, the state tax commissioner said that the estimated cost would be just $6.1 million, reflecting not only the relatively small size of the Vermont population, but also the negligible impact that taxing Social Security has on tax revenue.
Why state tax breaks on Social Security are smart
Vermont's proposal addresses an issue that many high-tax states are having: keeping retirees from fleeing across their borders once they quit their jobs for good. Obviously, those who live in northern climes like Vermont often seek out locations with more favorable weather, and that makes places like Florida and Texas -- both of which also happen not to have any state income tax at all -- look attractive.
Yet as Gov. Scott pointed out in his budget address, weather isn't the only factor. Many Vermonters simply move across the Connecticut River to live in New Hampshire in retirement. New Hampshire also imposes no state income tax on its residents, making it a natural place for Vermont retirees to go if they want to stay relatively close to their old roots.
Vermont isn't the only state to have considered such moves recently. Last year, Minnesota and Connecticut also looked at Social Security tax relief for their seniors. Various financial pressures on state governments can make such moves difficult to make, but the idea is that they can pay for themselves if they spur seniors to stay in-state -- especially wealthier seniors who have money to spend and investments to earn taxable income.
Look for state taxes on Social Security to keep falling
Finally, the newly passed tax-reform bill offers another incentive for states to cut their Social Security-related income taxes. Going forward, state and local taxes will only be deductible on federal tax returns up to a maximum of $10,000 each year. Few low- and middle-income seniors will hit that target, but some higher earners will -- and they're the ones in the best position to move to tax-friendlier states if they don't get the treatment they want.