Social Security is far more important than most non-retirees assume. How important? Consider these two snippets from the Social Security Administration:
- 53% of elderly couples receive over half of their retirement income from Social Security.
- 74% of unmarried elderly receive over half of their retirement income from the program.
When one source accounts for over half of one's income, the taxes you pay on that income can be very important. While the federal government has a formula to tax benefits -- more on that below -- most states don't take a piece of the average retiree's Social Security pie.
But that's not the case in 13 states: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia.
But there's more to the story than that
First, let's review how the federal government decides what you owe.
Start by taking half of your Social Security benefits and adding them to your other source of income -- part-time work, nest egg disbursements, pensions, and so on.
- If you're single, and this total is under $25,000, your benefits aren't taxed. If the number is between $25,000 and $34,000, you might owe taxes on half of your benefits. If the number is over $34,000, you could owe taxes on up to 85% of your benefits.
- If you're married filing jointly, and this total is under $32,000, your benefits aren't taxed. If the number is between $32,000 and $44,000, you might owe taxes on half of your benefits. If the number is over $44,000, you could owe taxes on up to 85% of your benefits.
But we're just talking about state taxes on Social Security benefits. "Why does this matter?" you may ask. It's because in four of these 13 states, the same rules are followed for determining how much you'll owe in state taxes on Social Security income. Those states are Minnesota, North Dakota, Vermont, West Virginia, and Rhode Island -- though Rhode Island is changing its formula moving forward.
What about the other nine states?
If you're retired in one of the remaining nine states, there are varying levels of relief that you can get from paying taxes on your Social Security. Using data from Kiplinger's and state tax websites, here's a brief summary of how your taxes can be calculated.
|State||AGI in Retirement Exempt Before Being Taxed||Given That You Are ...|
|Colorado||$20,000||Under 65 years old|
|$24,000||65 years old and over|
|$60,000||Married filing jointly|
|Kansas||$75,000||Resident of state|
|$100,000||Married filing jointly|
|$32,000||Married filing jointly|
|$58,000||Married filing jointly|
|New Mexico||$8,000||Over 65 with AGI of $28,500 or less ($51,000 for married filing jointly)|
|$100,000||Married filing jointly|
You might have noticed that Utah still hasn't been covered. That's because the state offers a tax credit of $450 for individual filers, and $900 for those who are married and filing jointly. The tax credit begins to phase out when adjusted gross income eclipses $25,000 per year ($32,000 for married filing jointly).
Putting it all together
None of this is to say that you should make any decisions about where to live in retirement based solely on Social Security taxes. In the real world, such decisions are more often dictated by how connected you feel toward your community, and how close family and friends are.
And even if these finances will play an important role, it's important to take the state's entire tax picture into consideration -- not just Social Security taxes. When you do so, you're making sure that you don't encounter any unwelcome surprises when it comes time to pay taxes next April.
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