Even in retirement, taxes may be unavoidable. Not only are your retirement account withdrawals sometimes subject to income taxes, but you could owe taxes on your Social Security benefits, too.
Social Security taxes can be tricky, but if you're not prepared for them, they could take a significant bite out of your monthly income. There are two types that could affect your benefit amount, but they won't apply to everyone. Here's what you need to know.
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1. State taxes
Depending on where you live, your benefits could be subject to state taxes. The good news is that most states don't tax Social Security, and among those that do, there are usually exemptions based on your age or income.
Currently, 38 states don't tax Social Security benefits. The 12 that still tax benefits to some degree include:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
However, Missouri will stop taxing Social Security benefits altogether starting next year, and Nebraska is also phasing out taxes, with benefits being fully exempt by 2025. Many other states are also reviewing their Social Security tax laws, so this list could easily change in the future.
Even if you live in a state that taxes benefits, you may still be able to get off the hook. In Rhode Island, for example, you may be exempt from state taxes if you've reached your full retirement age and have an adjusted gross income below $95,800 per year for individuals or $119,750 per year for married couples filing jointly.
Again, these tax laws are always changing, and more states have been repealing their Social Security taxes in recent years. If your state still taxes benefits or if you're not exempt, keep an eye on your state's laws in case that changes.
2. Federal taxes
Federal taxes apply to everyone regardless of location, and they are dependent on a figure called your provisional income.
Your provisional income is half of your annual Social Security benefit plus your adjusted gross income and any nontaxable interest. So, for example, if you're collecting $20,000 per year from Social Security and withdrawing $40,000 per year from your 401(k), your provisional income would be $50,000 per year.
| 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.
The good news is that no matter how much you're earning, you won't pay federal taxes on more than 85% of your benefit amount. The bad news is that the only way to get out of federal taxes is if your provisional income is below $25,000 per year (or $32,000 per year for married couples).
That said, there is a loophole that could reduce or even eliminate federal taxes: invest in a Roth account. Withdrawals from Roth accounts (such as a Roth 401(k) or Roth IRA) do not count toward your provisional income.
In the previous example, you're pulling savings from a 401(k) and have a provisional income of $50,000 per year. In that case, up to 85% of your benefits would be taxable. But if you instead withdrew that money from a Roth IRA, your provisional income would be just $10,000 per year -- and you could avoid federal taxes altogether.
Social Security taxes can be confusing, but it pays to at least know the basics about what type of taxes you can expect in retirement. While you may not be able to avoid them, the more you're able to plan, the better off you'll be.
