Navigating finances in retirement isn't always the easiest or most straightforward process. You have to consider retirement accounts and their withdrawal processes, investment income, and the role Social Security will play.

By itself, Social Security can already be complex, and there are some details that retirees can somewhat gloss over. However, one of those details should not be how taxes on Social Security works. For the millions of Americans who will rely heavily on Social Security in retirement, knowing the tax implications and how it affects benefits is crucial for properly planning retirement finances.

If you're a resident of one of the states that taxes Social Security benefits, you may need to plan for a lower payout than Social Security may be projecting based on your earnings record.

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Tax scenarios vary by state

Thankfully, most states don't tax Social Security benefits, but for 2024, there are 10 exceptions that may tax a portion of them:

  • Colorado
  • Connecticut
  • Kansas
  • Minnesota
  • Montana
  • New Mexico
  • Rhode Island
  • Utah
  • Vermont
  • West Virginia

I use the word "possibly" because each state sets its rules regarding who gets taxed and how much. For example, in Colorado, people aged 65 and older are fully exempt from state taxes on Social Security, and people aged 55 to 64 can deduct up to $20,000 of Social Security benefits from their taxable income. However, anybody with an adjusted gross income over $75,000 in Kansas is subject to state Social Security taxes (5.7%).

It's also important to keep up with your state's Social Security tax rules because they can change from year to year. West Virginia, for example, taxed Social Security benefits until 2022. Missouri and Nebraska taxed them through 2023 but has phased them out for the 2024 tax year.

State rules don't excuse you from federal tax laws

Regardless of your state, federal tax rules apply to Social Security benefits. It's like regular income tax: Even if your state doesn't tax it, you still have to pay federal income taxes. One big difference, though, is that the IRS uses a figure it calls "combined income" to determine how much you owe instead of standard tax brackets.

Your combined income is your adjusted gross income (earnings, dividends, capital gains, retirement account distributions, etc.) plus half of your annual Social Security benefit and all nontaxable interest (like Treasury and municipal bonds).

For example, if someone's AGI is $75,000, and they receive $22,000 annually from Social Security and $2,000 from Treasury bond interest, their combined income would be $87,000. Below is how much of your Social Security benefits will be eligible to be taxed based on your provisional income:

 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.

A critical detail to understand is that those percentages aren't the amount your Social Security benefits will be taxed. It's the amount that's eligible to be taxed. A married person filing jointly with a provisional income of $80,000 wouldn't have 85% of their benefits taxed, but 85% would be eligible to be taxed.

The amount you pay will ultimately depend on your regular income tax bracket.

A Roth IRA could be a way to lower your federal tax bill

Roth IRAs allow you to take tax-free withdrawals in retirement, so any money from them isn't counted toward your gross income -- and, therefore, combined income.

By having a Roth IRA to withdraw from, you could possibly lower how much you withdraw from a retirement account like a 401(k) or traditional IRA, which counts toward your gross and provisional income. Unless you're at the age of required minimum distributions, only having Roth IRA income could lower your bracket for taxable Social Security benefits.

Imagine you're single and have $35,000 in combined income. At that point, up to 85% of your Social Security benefits would be eligible to be taxed. If you took Roth IRA withdrawals instead of 401(k) withdrawals and it lowered your combined income to $30,000, only up to 50% of your benefits would be taxable.

Anytime you can save money, you should -- especially in retirement, when every dollar becomes much more valuable.