Arguably one of the toughest challenges we face is ensuring we have enough money to last throughout our lifetime.
As Americans, we're almost predisposed to the notion that we're poor savers; and we're also living longer than ever before, meaning there's even more pressure for our nest egg. Ensuring we have the appropriate budget, investment plan, and withdrawal plan in place is critical to hitting our retirement goals. But things don't always work out as planned.
Why leaning heavily on Social Security can be worrisome
According to a survey completed by AARP in September of pre-retirees ages 45 to 64, roughly half (51%) planned to lean on their Social Security benefits to provide 41% or more of their household income in retirement, including almost a quarter expecting it to comprise 71% or more of their household income. The Social Security Administration advises that your benefits shouldn't total more than 40% of your household income during retirement.
The big concern with retirees and pre-retirees relying so heavily on Social Security benefits is that the program is in need of a fix. A demographic shift caused by the retirement of baby boomers, and the aforementioned increase in life expectancy, is expected to drain the Trust's remaining cash reserves by 2034. In short, beneficiaries could be facing a 21% benefits cut in order to sustain the program through 2087. That's not a spot retirees want to find themselves in.
But other Social Security pitfalls exist for those who aren't prepared for retirement.
Four states that tax Social Security benefits without any exemptions
For example, 13 states currently tax Social Security benefits, at least to some extent. There's always the glass half-full approach which shows that three-quarters of all states do not tax your Social Security benefits during retirement. But, if you happen to retire in one of the 13 states that does, and you aren't aware of it ahead of time, it could wind up being a very unpleasant surprise.
"What states tax Social Security benefits," you wonder? According to Kiplinger, Colorado, Connecticut, Kansas, Montana, Minnesota, Missouri, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia all tax Social Security to some degree.
The good news is that nine of these states have made up their own rules and allow retirees an exemption from having their benefits taxed up to a certain amount of income. In Colorado, for instance, up to $20,000 in Social Security and retirement income for those younger than 65 may be exempted, and this level rises up to $24,000 for those ages 65 and up. Missouri has a considerably more relaxed policy that taxes Social Security beneficiaries only if individual adjusted gross incomes exceed $85,000, or $100,000 for married couples.
However, four states -- Minnesota, North Dakota, Vermont, and West Virginia -- offer no exemption to retirees, and thus follow the federal government's tax schedule for Social Security. The IRS taxes 50% of Social Security benefits at the ordinary federal income tax rate for income between $25,000 and $34,000 for individuals and $32,000 to $44,000 for those who file a joint return. For individuals with incomes above $34,000 and joint filers with incomes surpassing $44,000, 85% of Social Security benefits becomes taxable at the ordinary income rate. Retirees in these states who haven't done their homework could wind up forking over much needed cash via taxation during their golden years.
One important thing to keep in mind
Whether you're already retired, or preparing to head into retirement in the coming years or decades, it's important that you keep one thing in mind. Namely, you should understand that where you retire can make a big difference as to how long your nest egg lasts. Understanding how your retirement income, including pensions and other investments, is taxed should be near the top of your list when it comes to preparing for retirement.
Of course, there are a long list of factors you'll likely want to weigh when considering where to retire, and those factors will probably extend beyond just whether or not a state taxes Social Security benefits. For instance, even though West Virginia taxes Social Security benefits at the same rate as the federal government, and without exemption, it does offer income exemptions on the first $8,000 ($16,000 for married couples) withdrawn from IRAs, 401(k)s, and private pensions. It also has a reasonable sales tax and low property taxes, making it a fairly tax-friendly state minus the Social Security benefits tax.
Make it a point to be a proactive pre- and post-retiree and don't let these taxes surprise you at the most inopportune of times.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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