Social Security is a lifeline for millions of older adults, but there's a chance you may not receive as much as you're expecting. Even in retirement, you may be subject to taxes -- and this often includes Social Security benefits.
More than 40% of U.S. adults are unaware that they could owe taxes on their monthly payments, according to a 2023 survey from the Nationwide Retirement Institute, so many retirees could be in for an unwelcome surprise. While taxes can be complicated and confusing, there are two important types of taxes that could affect your benefit amount.
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1. State taxes
Whether your benefits are subject to state taxes will depend primarily on where you live, and the good news is that 38 states do not tax Social Security at all. Also, of the 12 states that do tax benefits, there are often exemptions based on income or age.
In Connecticut, for example, those with an adjusted gross income of less than $75,000 per year (or $100,000 per year for married couples filing jointly) are fully exempt from state taxes on their benefits. And in Rhode Island, you'll become exempt from taxes once you reach your full retirement age (or if your income falls below $95,800 per year or $119,750 per year for joint filers).
These laws are constantly changing, too. Even if you live in a state that currently taxes Social Security, there's always a possibility it could be phased out in the coming years.
2. Federal taxes
Federal taxes apply to everyone, regardless of where you live, and they're determined based on your income in retirement.
First, you'll need to know a figure called your "provisional income." This is your adjusted gross income (such as retirement account withdrawals) plus 50% of your annual Social Security benefit and any nontaxable interest.
For example, if you're withdrawing $30,000 per year from your 401(k) and receiving $20,000 per year from Social Security, your provisional income would be $40,000 per year. Here's how much of your benefits could be taxed depending on your provisional income:
| Percentage of Your Benefits Subject to Federal Taxes | Provisional Income for Individuals | Provisional Income for 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 |
Source: Social Security Administration.
If these income limits seem low, it's because they are. They haven't been adjusted since 1984 when Social Security first became subject to federal income taxes. As the general cost of living continues to increase, more people will likely owe taxes on their benefits.
How to get out of paying federal taxes
The bad news is that unless your provisional income falls below $25,000 per year (or $32,000 per year for married couples), you'll owe taxes on a portion of your benefits. The good news, though, is that there's a loophole that can help you reduce your tax bill.
Withdrawals from Roth accounts -- such as a Roth IRA or Roth 401(k) -- don't count toward your provisional income. If enough of your savings are in this type of account, you could reduce or even eliminate federal taxes on your benefits.
For instance, in the previous example, you're withdrawing $30,000 per year from a 401(k) while collecting $20,000 per year from Social Security. That gives you a provisional income of $40,000 per year, and up to 85% of your benefits would be taxable if you're filing as an individual.
However, say that instead of pulling that $30,000 per year from a 401(k), you withdraw it from a Roth IRA. In this case, your provisional income would only be half of your annual benefit, or $10,000 per year -- and none of your benefits would be subject to federal taxes.
Social Security taxes can be confusing, but it pays to at least have a basic understanding of the types of taxes you may be subject to in retirement. The more prepared you are, the easier it will be to maximize your income and avoid any costly surprises.
