Retired workers typically pay some combination of property tax, sales tax, state income tax, and federal income tax, but many Americans don't understand how Social Security income fits into the equation. That makes it difficult to plan for retirement.
Read on to learn how the federal government taxes Social Security benefits, which states do not tax benefits, and how retirees can reduce their tax burden.
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How the federal government taxes Social Security benefits
Social Security benefits are subject to federal income tax when combined income exceeds certain thresholds. The term combined income refers to the sum of your adjusted gross income, nontaxable interest, and one-half of Social Security income.
The chart below details the various combined income thresholds, and it illustrates the portion of Social Security benefits subject to taxation at each threshold.
|
Taxable Portion of Benefits |
Single Filers |
Joint Filers |
|---|---|---|
|
0% |
Under $25,000 |
Under $32,000 |
|
50% |
$25,000 to $34,000 |
$32,000 to $44,000 |
|
85% |
Above $34,000 |
Above $44,000 |
Data source: The Social Security Administration.
Retirees can use this calculator from the IRS to clarify what portion (if any) of their Social Security benefits are subject to federal income tax.
The 38 states that do not tax Social Security benefits
Currently, 12 states tax Social Security to some degree, though rules regarding deductions and exemptions vary on a case-by-case basis. As detailed below, the remaining 38 states (plus the District of Columbia) do not tax Social Security benefits. Eight of those states do not tax income at all, and New Hampshire doesn't tax most income.
- Alabama
- Alaska (no state income tax)
- Arizona
- Arkansas
- California
- Delaware
- District of Columbia
- Florida (no state income tax)
- Georgia
- Hawaii
- Idaho
- Illinois
- Indiana
- Iowa
- Kentucky
- Louisiana
- Maine
- Maryland
- Massachusetts
- Michigan
- Mississippi
- Nevada (no state income tax)
- New Hampshire (no state income tax, except on dividends and interest)
- New Jersey
- New York
- North Carolina
- North Dakota
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- South Carolina
- South Dakota (no state income tax)
- Tennessee (no state income tax)
- Texas (no state income tax)
- Virginia
- Washington (no state income tax)
- Wisconsin
- Wyoming (no state income tax)
The list above is set to get a little bit longer in the next few years. Missouri will stop taxing Social Security in 2024, and Nebraska will stop taxing benefit payments in 2025.
Additionally, four states on the list -- Illinois, Iowa, Mississippi, and Pennsylvania -- generally do not tax retirement income. That means 401(k) and IRA distributions, pension payments, and Social Security benefits are tax-free for residents, provided they follow state-specific rules regarding withdrawal age.
How to minimize taxes (or increase benefits) in retirement
Short of moving to a tax-friendly state, there are other ways to minimize taxes in retirement. For instance, workers can invest money in Roth IRAs and Roth 401(k)s. Contributions to Roth accounts are taxed up front, so qualified withdrawals are tax-free. That means distributions are not subject to capital gains tax, nor do they count toward taxable income at the federal or state levels.
Additionally, retirees can draw down tax-deferred accounts like traditional IRAs and 401(k)s before claiming Social Security. That strategy may or may not reduce their tax burden, but delaying Social Security will most certainly increase their future benefit payments.
Finally, retirees can adopt a long-term mindset when investing, which means holding stocks for longer than one year. Short-term capital gains are generally taxed at the same rate as ordinary income, but long-term capital gains are taxed less aggressively.
Cost of living and quality of life matter more than state-specific tax laws
Relocating to minimize taxes in retirement is a fine strategy in certain circumstances, but retirees should consider the overall cost of living when making decisions. For instance, Hawaii, the District of Columbia, Massachusetts, California, and New York do not tax Social Security benefits, but those are the five most expensive places to live in the U.S., according to the Missouri Economic Research and Information Center.
Retirees should also consider factors that influence quality of life, especially proximity to friends and family. Relocating to minimize taxes in retirement is not logical if it makes life much less enjoyable.
