Many Americans misunderstand certain aspects of Social Security, and those knowledge gaps can lead to lost income in retirement. For instance, more than half of adults surveyed by Nationwide Retirement Institute incorrectly agreed with this statement: "Social Security benefits are tax free."
The correct answer is Social Security benefits are taxable at the federal and state levels, but only 12 states (soon to be 10) tax benefits in certain situations. That means some retired workers living in those states risk losing a portion of their Social Security income.
Here are the details.
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Social Security benefits are taxable at the federal level
Social Security benefits are subject to federal income tax when combined income exceeds certain thresholds. For context, combined income equals adjusted gross income (AGI) plus nontaxable interest plus one-half of Social Security benefits.
The chart below details the taxable portion of Social Security benefits at different combined income thresholds based on filing status.
|
Taxable Portion of Benefits |
Combined Income (Single Filers) |
Combined Income (Joint Filers) |
|---|---|---|
|
50% |
$25,000 to $34,000 |
$32,000 to $44,000 |
|
85% |
$34,001+ |
$44,001+ |
Data source: The Social Security Administration.
Unlike federal tax brackets, combined-income thresholds are not adjusted for inflation each year, nor have they ever been adjusted since their implementation in 1984. That is problematic because $25,000 in 1984 has the same purchasing power as $75,000 in 2023. That means the federal government is effectively taxing benefits more aggressively with each passing year.
Social Security benefits are taxable at the state level
Social Security benefits are subject to state income tax in 12 states, though that figure will drop to 10 in the coming years as Missouri and Nebraska plan to stop taxing benefits in 2024 and 2025, respectively.
The extent to which benefits are taxed at the state level varies on a case-by-case basis. The details provided below are relevant to the 2022 tax year (i.e., returns filed in 2023).
Colorado: The state tax rate is 4.4%. Social Security recipients aged 65 and older can deduct all federally taxable benefit income, while those aged 55 to 64 can deduct up to $20,000.
Connecticut: The state tax rate ranges from 3% to 6.99%. Benefits are exempt from taxation for (1) single filers with a federal AGI below $75,000 and (2) joint filers with a federal AGI below $100,000. Individuals exceeding those thresholds will pay tax on no more than 25% of their total Social Security income.
Kansas: The state tax rate ranges from 3.1% to 5.7%. Benefits are exempt from taxation for taxpayers with a federal AGI of $75,000 or less.
Minnesota: The state tax rate ranges from 5.35% to 9.85%. Social Security recipients with a combined income below certain thresholds can deduct a portion of federally taxable benefits. The maximum deduction is $4,560 for single filers and $5,840 for joint filers.
Missouri: The state tax rate ranges from zero to 5.3%. Benefits are exempt from taxation for (1) single filers with a federal AGI below $85,000 and (2) joint filers with a federal AGI below $100,000. Missouri will stop taxing benefits altogether in 2024.
Montana: The state tax rate currently ranges from 1% to 6.75%, but it will contract to 4.7% to 5.9% next year. Montana uses a state-specific formula to determine the taxable portion of benefits, and it actually taxes Social Security more aggressively than the federal government in some cases.
Nebraska: The state tax rate ranges from 2.46% to 6.84%. Benefits are exempt from taxation for (1) single filers with a federal AGI up to $45,790 and (2) joint filers with a federal AGI up to $61,760. Nebraska will completely phase out the taxation of Social Security benefits by 2025.
New Mexico: The state tax rate ranges from 1.7% to 5.9%. Benefits are exempt from taxation for (1) single filers with a federal AGI below $100,000 and (2) joint filers with a federal AGI below $150,000.
Rhode Island: The state tax rate ranges from 3.75% to 5.99%. Benefits are exempt from taxation for (1) single filers with a federal AGI below $95,800 and (2) joint filers with a federal AGI below $119,750.
Utah: The state tax rate is 4.85%, dropping to 4.65% in 2023. Benefits are exempt from taxation for (1) single filers with a modified AGI (MAGI) below $37,000 and (2) joint filers with a MAGI below $62,000. In 2023, the MAGI threshold will increase to $45,000 for single filers and $75,000 for joint filers.
Vermont: The state tax rate ranges from 3.35% to 8.75%. Benefits are exempt from taxation for (1) single filers with a federal AGI up to $50,000 and (2) joint filers with a federal AGI up to $65,000.
West Virginia: The state tax rate ranges from 3% to 6.5%. Benefits are exempt from taxation for (1) single filers with a federal AGI up to $50,000 and (2) joint filers with a federal AGI up to $100,000.
States that tax Social Security benefits are not necessarily worse
The 12 states that tax Social Security are not necessarily worse (or even more expensive) than the 38 states that do not tax benefits. Retired workers need to consider other variables that impact quality of life, including overall cost of living, proximity to friends and family, and even climate. For instance, three states that tax benefits -- Kansas, West Virginia, and Missouri -- actually rank among the 10 states with the lowest cost of living, according to the Missouri Economic Research and Information Center.
Here's the bottom line: A smaller tax bill is little consolation if it makes life less enjoyable.
