Social Security is a central piece to most Americans' retirement plans. Around half of retirees 65 or older receive at least 50% of their household income from their monthly benefit checks, according to data analyzed by the Social Security Administration. So the thought of losing even a portion of those benefits could have a drastic impact on many people's budgets in retirement.
Unfortunately for those living in 10 states, there's a chance they'll see a reduction in their Social Security checks. Depending on your income, the state government may impose income tax on a portion of your benefits.
Here's what you need to know.
How the federal government taxes Social Security
Before we dive into the details of state taxes, anyone collecting Social Security, or who's about to start collecting, needs to know the details of how the federal government taxes that income.
The federal government uses a metric called "combined income" to determine what portion, if any, of your Social Security benefits are taxable. Combined income is equal to the sum of your adjusted gross income, any nontaxable interest income, and half of your Social Security income. If your combined income exceeds a certain threshold, a portion of your Social Security becomes subject to taxation.
The following table shows what portion of your Social Security benefits are taxed at the combined income thresholds.
| Taxable Portion of Benefits | Individual | 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% | $34,001 and up | $44,001 and up |
Data source: Social Security Administration.
If you find those thresholds extremely low, you're not alone. That's because the numbers haven't been adjusted for inflation for at least 30 years. As such, more and more households are finding it nearly impossible to stay below those thresholds and avoid taxes on their Social Security benefits. Careful tax planning can help mitigate the impact of Social Security taxes at the federal level, but retirees in 10 states have to worry about state taxes, too.
Image source: Getty Images.
10 states that tax Social Security
Tax laws vary from state to state. While most states don't tax any portion of Social Security no matter what, these 10 have special rules that may make some of your benefits subject to income tax.
If you live in one of these states, you should take the time to do some additional research or consult a tax professional to learn more about your specific situation and how to mitigate your tax bill. In the meantime, here are the basics.
Colorado: Taxpayers under 65 with more than $20,000 in taxable benefits on their federal income tax return will owe state income taxes on the amount above that threshold. Retirees 65 or older are exempt from taxes on Social Security benefits. The state tax rate is 4.4%.
Connecticut: Any Social Security income included on your federal income tax return may be subject to taxes in Connecticut. However, the amount is limited to 50% of your benefits received regardless of what percentage is included on your federal return. The tax rate ranges from 2% to 4.5%.
Kansas: Taxpayers will owe state income taxes on any Social Security benefits also subject to federal income tax if their adjusted gross income exceeds $75,000. The tax rate is 5.7%.
Minnesota: Taxpayers can deduct up to $4,560 as an individual or $5,840 for a married couple filing jointly in Social Security benefits from their taxable income. That amount is reduced for residents with combined incomes above $69,250 for an individual or $88,630 for a married couple before phasing out completely at incomes of $78,000 or $100,000, respectively. The tax rate ranges from 6.8% to 9.85%.
Montana: Any Social Security income on your federal income tax return is subject to state income tax in Montana. The tax rate ranges from 4.7% to 5.9%.
New Mexico: Taxpayers with adjusted gross incomes exceeding $100,000 for individuals or $150,000 for married couples filing jointly will owe taxes on any Social Security income also taxed at a federal level. The tax rate ranges from 4.9% to 5.9%.
Rhode Island: Taxpayers below their full retirement age as defined by Social Security with an adjusted gross income above $101,000 for individuals or $126,250 for married couples filing jointly will owe taxes on any portion of Social Security income also included on their federal income tax return. The tax rate ranges from 4.75% to 5.99%.
Utah: Taxpayers with an adjusted gross income exceeding $45,000 for individuals or $75,000 for married couples filing jointly will owe taxes on any Social Security income included on their federal tax return. Those below the threshold qualify for a credit to offset the taxes. The tax rate is 4.65%.
Vermont: Taxpayers with an adjusted gross income above $50,000 for individuals or $65,000 for married couples filing jointly will owe income tax on at least a portion of any Social Security income included on their federal income tax return. The tax rate ranges from 3.35% to 8.75%.
West Virginia: Taxpayers with adjusted gross income above $50,000 for individuals or $100,000 for married couples filing jointly owe income tax on a portion of Social Security income included in their federal income tax return. The tax rate ranges from 5.1% to 5.525%.
Read this before you decide to retire somewhere else
Just because these 10 states might tax some of your Social Security benefits, that shouldn't be the reason you avoid retiring in one of them. There's a lot more to enjoying your retirement than saving a few bucks on taxes. And you never know when legislation might change. Twelve states taxed Social Security last year, and the number keeps getting smaller.
Many of these 10 states have a low cost of living or great communities for seniors, or both. What's more, they might put you close to family or friends, which can be one of the most important factors in retirement when you no longer have a job to occupy all your time. Even if you have a slightly higher tax bill, it might be a price worth paying.
Importantly, there are several strategies you can use to help keep taxes low in retirement without having to change states. Using tax-free withdrawals from Roth accounts and carefully planning capital gains can have a much bigger impact on your tax bill than state taxes on Social Security income.
