America's reliance on Social Security has almost never been higher. An April survey from national pollster Gallup found that 89% of current retirees lean on Social Security as a major or minor source of income during retirement. What's more, a record-high 88% of nonretirees now expect to be reliant on the program to make ends meet when they retire.
But a big surprise may await tens of millions of future retirees.
Uncle Sam might be entitled to part of your Social Security benefit check
Whether you realize it or not, Social Security benefits may be taxable at the federal level.
Back in 1983, under the Reagan administration, Congress passed the last major bipartisan overhaul of the Social Security program. The Amendments of 1983 gradually increased the program's full retirement age over a four-decade stretch, boosted revenue collection via the payroll tax, and most importantly, introduced the taxation of benefits, which took effect in 1984.
The taxation of benefits allows the federal government to collect tax on up to half of all benefits paid if an individual's modified adjusted gross income (MAGI) plus one-half of benefits exceeds $25,000 ($32,000 for a couple filing jointly).
In 1993, under the Clinton administration, Congress added a second tier of taxation on Social Security benefits. If an individual or couple filing jointly were to respectively exceed $34,000 and $44,000 using the MAGI plus one-half benefits formula, up to 85% of their benefits paid above this threshold can be exposed to federal taxation.
Although most seniors despise the idea of paying tax on a portion of their Social Security benefits, and a number of lawmakers have lobbied for this practice to stop, the taxation of benefits is unlikely to go away. With Social Security facing an estimated $16.8 trillion cash shortfall between 2035 and 2094, every cent in revenue will be needed to prop up the program -- and that includes the taxation of benefits.
Select states tax Social Security income, too
But here's the real shocker -- more than a dozen states might also be coming after your Social Security benefits. The following 13 states, listed in alphabetical order, tax Social Security income to some varied degree:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
Your initial reaction might be to avoid these states like the plague when you're in retirement. If you're a high-earning individual or couple, this might be a smart move, based solely on the potential tax savings at the state level -- although you'll still owe federal tax on 85% of the benefits you receive. Yet what's interesting is that many of these 13 states have become much tax-friendlier to retirees in recent years.
For instance, five years ago, Minnesota, North Dakota, Vermont, and West Virginia all had Social Security tax policies in place that mirrored the federal government's. In other words, double taxation was a very real possibility for beneficiaries living in these states. However, all four have since amended their tax policies on Social Security benefits, with West Virginia expected to completely phase out the taxation of benefits by 2022.
Many of the other states on this list offer generous exemptions to retirees receiving Social Security. For example, individual taxpayers in Connecticut and Kansas can generate up to $75,000 in adjusted gross income (AGI) before any state-level benefit taxation would kick in. Missouri and Rhode Island are even more forgiving, with exemption thresholds of $85,000 and $85,150 in AGI, respectively. If you choose to live in a state that taxes Social Security benefits and aren't a high-earning individual or couple, there's a decent chance you're not going to owe any state-level tax on your benefits.
The point is, be mindful of where you choose to call home, because no one likes a tax surprise during retirement.