It's no secret that your retirement location can significantly affect your retirement costs. Somebody retiring in Santa Monica, California, will likely need more money than someone retiring in Myrtle Beach, South Carolina. That part of retirement expenses is straightforward, but your retirement income could also be affected -- especially when it comes to Social Security.
For many people, Social Security accounts for a good portion of their retirement income. Unfortunately, retirees in these 12 states should be aware they could end up giving some of that money back to Uncle Sam.
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Which states tax Social Security benefits?
The good news is 38 states don't tax Social Security benefits at all. The bad news is there are 12 states that could potentially tax at least a portion of your Social Security benefits under certain circumstances:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
Although these states could possibly tax your Social Security benefits, it's not guaranteed they will. Each state has its respective rules about who it taxes and how much.
For example, in Colorado, retirees aged 65 and older can fully deduct Social Security benefits from their state income. However, beneficiaries 55 to 64 must pay a 4.4% tax on any retirement income over $20,000, including Social Security. Kansas, on the other hand, has it set so only retirees with an adjusted gross income (AGI) over $75,000 will pay taxes.
In the above scenario, a 66-year-old retiree with an AGI of $80,000 would owe taxes on Social Security if they lived in Kansas but not if they lived in Colorado. Conversely, a 63-year-old retiree with an AGI of $60,000 could potentially owe taxes in Colorado but not Kansas.
That's why it's important to ensure you're aware of how your state treats Social Security benefits as well as retirement income in general.
Don't forget about federal taxes
There are layers to the tax game. Just because you can avoid state taxes doesn't mean you can avoid federal taxes. Retirees across all states are subject to federal taxes on their Social Security benefits if their provisional income crosses thresholds based on their tax filing status.
The government considers provisional income as your AGI plus half of your annual Social Security benefits and all nontaxable interest. Here's how much of your Social Security benefits could be taxed based on your provisional income and filing status:
|
Potential Percentage of Taxable Benefits |
Filing Single |
Married, Filing Jointly |
|---|---|---|
|
0% |
Less than $25,000 |
Less than $32,000 |
|
Up to 50% |
$25,000 to $34,000 |
$32,000 to $44,000 |
|
Up to 85% |
More than $34,000 |
More than $44,000 |
Data source: Social Security Administration.
For a single filer with an AGI of $40,000, this doesn't mean 85% ($34,000) of their Social Security benefit will be taken in taxes -- it means $34,000 will be eligible to be taxed. That's a very important distinction. The actual amount of tax you owe will depend on your tax bracket.
Using a Roth IRA could help out
A Roth IRA is a retirement account that allows you to contribute after-tax money and take tax-free withdrawals in retirement. It's essentially a brokerage account with a huge tax break.
One way to reduce the chance of owing taxes on your retirement income is by taking advantage of a Roth IRA.
As long as you're taking Roth IRA withdrawals, it won't count toward your AGI or overall taxable income. Having enough Roth IRA income to only need $30,000 in AGI instead of $40,000, for example, could be the difference of up to 85% versus up to 50% of your benefits being subject to federal taxes.
