Social Security can be a lifeline for millions of retirees, especially right now. A whopping 85% of retired Americans say that rising inflation is stretching their budgets, according to a 2022 survey from The Motley Fool, and 40% rely on Social Security "completely" in retirement.
It's more important than ever, then, to make the most of your benefits. But for retirees in 12 states, taxes could take a bite out of monthly payments.
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How taxes will affect your benefits
Even in retirement, you may not be able to escape taxes. Depending on where you live, your Social Security benefits may be subject to state income taxes.
Fortunately, 38 states don't tax Social Security, so there's a good chance you can avoid these taxes altogether. The 12 states that do tax benefits include:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
The good news, though, is that even among states that tax Social Security, most have exemptions based on income or age.
In Missouri, for example, you're exempt from Social Security taxes if your adjusted gross income is below $85,000 per year (or $100,000 per year for married couples). And in Rhode Island, you're exempt once you reach your full retirement age, as long as your income is below $95,800 per year (or $119,750 per year for married couples).
Because each state has unique regulations surrounding Social Security, it's wise to check your state's laws to determine whether your benefits will be subject to taxes.
Don't forget about federal taxes
State taxes are only one part of the equation. All Social Security recipients, regardless of location, can also be subject to federal taxes on benefits.
Your federal taxes are determined based on your provisional income, which is your adjusted gross income plus half of your annual Social Security benefit amount and any nontaxable interest. For instance, if you're withdrawing $40,000 per year from your 401(k) and earning $20,000 per year from Social Security, your provisional income would be $50,000 per year.
Here's how much you could owe in federal taxes, depending on your provisional income:
| Percentage of Your Benefits Subject to Federal Taxes | Provisional Income (Single Filers) | Provisional Income (Married Couples Filing Jointly) |
|---|---|---|
| 0% | Under $25,000 per year | Under $32,000 per year |
| Up to 50% | $25,000 to $34,000 per year | $32,000 to $44,000 per year |
| Up to 85% | More than $34,000 per year | More than $44,000 per year |
In other words, the only way to avoid federal taxes entirely is if your provisional income falls below $25,000 per year (or $32,000 per year for married couples). However, no matter how much you're earning, you won't pay federal taxes on more than 85% of your benefit amount.
That said, there is a loophole to help avoid federal taxes: Invest in a Roth account. Roth IRA and Roth 401(k) withdrawals are not included in your provisional income, so if the majority of your savings are in this type of account, you could reduce your provisional income enough to not owe federal taxes.
Taxes can be complicated and confusing, especially when everyone's situation is different. But when you know what to expect in retirement, it's easier to plan accordingly.
