There's a good chance Social Security will end up being an important source of income for you once you retire. Even if you manage to accumulate a nice nest egg, you never know if your savings might erode due to factors like stock market downturns and inflation. The good thing about Social Security is that once you file for benefits, you're guaranteed a certain monthly payday for life. It's not like your benefits are going to shrink because the stock market underperforms one year.
But one thing many seniors don't realize is that Social Security can be taxable in certain situations. If you earn too much money as a retiree, the federal government might tax a portion of your benefits.
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Additionally, there are some states that impose their own taxes on Social Security income. And it's important to know if your state is on that list so you can plan accordingly.
The 12 states that tax Social Security
First, the good news -- the majority of U.S. states do not tax Social Security benefits. But if you live in one of these 12 states, taxes might be a concern:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
That said, many of these states do offer an exemption on Social Security benefit taxes for lower and even moderate earners. So you might be able to get out of paying state taxes on your Social Security after all.
It's also worth noting that some of these states offer specific benefits that make them a smart choice for retirees. West Virginia, for example, has a cost of living that's well below the national average, according to Sperling's Best Places. The same applies to Kansas.
Colorado isn't a particularly inexpensive place to call home -- as a retiree or worker. But it's known for its amazing scenery and outdoor amenities. So if that's important to you, then it may be worth taking the risk that the state of Colorado will tax some of your Social Security income.
Know what taxes lie ahead
When you're retired and on a fixed income, you can't afford financial surprises, so it's important to know what sort of taxes to expect before your career comes to an end.
You might, as mentioned, pay taxes on your Social Security benefits at the federal level, the state level, or both. But other sources of retirement income might be taxable, too, like your pension or withdrawals from a traditional IRA or 401(k) plan.
On the other hand, there are plenty of retirement income sources that aren't taxable. HSA withdrawals used for healthcare spending are yours to enjoy tax-free, as are distributions from a Roth IRA or 401(k). And if you own municipal bonds, the interest income you receive is always tax-exempt at the federal level and is sometimes exempt from state and local taxes as well (namely, if you buy bonds issued by your state of residence).
There are plenty of strategies you can employ to lower your tax burden as a retiree and stretch your income. But it's important to avoid tax surprises to the greatest extent possible. And that means knowing what tax implications you're looking at based on the state you decide to call home.
