Social Security benefits are a lifeline for many retirees, providing much-needed financial stability. However, knowing how these benefits are taxed is essential for maximizing your retirement income. While federal taxes on Social Security payments are widely known, some states also impose their own taxes on these benefits. Let’s look into why Social Security is taxed, which states to watch out for, and strategies to minimize taxes on your benefits.
Table of Contents
Social Security Benefits
Social Security benefits are considered part of your income by the IRS, which means they may be subject to federal income tax. Whether or not you pay tax depends on your total income, which includes Social Security payments, wages, dividends, and other income sources.
Federal Tax Thresholds
- Individual Filers:
- Combined income between $25,000 and $34,000: Up to 50% of benefits taxable.
- Combined income above $34,000: Up to 85% of benefits taxable.
- Joint Filers:
- Combined income between $32,000 and $44,000: Up to 50% of benefits taxable.
- Combined income above $44,000: Up to 85% of benefits taxable.
For clarity, the IRS defines combined income as your adjusted gross income (AGI) plus non-taxable interest and half of your Social Security benefits.
States
While most states do not tax Social Security benefits, nine states currently impose state income tax on these payments. If you’re considering a move in retirement, these are the states to be cautious of:
- Colorado
- Connecticut
- Minnesota
- Montana
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
Key Considerations
- Income Thresholds: Many of these states exempt Social Security benefits from state taxes if your income falls below a certain threshold. For example, New Mexico only taxes benefits for individual filers with an adjusted gross income exceeding $100,000.
- West Virginia’s Phase-Out: West Virginia is phasing out its Social Security tax, with complete elimination expected by 2026.
Strategies to Reduce Taxes
Roth IRA contributions are made with after-tax dollars, and withdrawals are tax-free. Because withdrawals from Roth IRAs don’t count toward your combined income, they can help lower the taxable portion of your Social Security benefits.
Plan Retirement Account Withdrawals
Strategically withdrawing funds from retirement accounts like traditional IRAs or 401(k)s before you claim Social Security benefits can reduce future taxable income. By managing your withdrawals, you may avoid crossing the thresholds that trigger higher taxes on Social Security.
State Exemptions
If you live in or plan to move to a state that taxes Social Security, research their income exemptions. Lowering your adjusted gross income may help you qualify for these exemptions, reducing or eliminating your state tax liability.
What’s Next?
Social Security is undergoing significant changes due to concerns about its long-term financial stability. Legislative actions this year could impact:
- Eligibility Criteria: Adjustments to age requirements or income thresholds.
- Benefit Calculations: Reforms to ensure program sustainability.
- Pension Offsets: New rules could change benefits for those also receiving public pensions.
Retirees should stay informed about these developments to know how their benefits might be affected.
Final Thoughts
Knowing how Social Security benefits are taxed is crucial for maximizing retirement income. While federal taxes are unavoidable for many beneficiaries, careful planning can help reduce the impact of state taxes. By choosing the right state to retire in and employing strategies like Roth IRA contributions and strategic withdrawals, retirees can keep more of their hard-earned benefits.
FAQs
Which states tax Social Security benefits?
Nine states, including Colorado, Utah, and Minnesota, tax benefits.
What income triggers federal taxes on benefits?
For individuals, combined income over $25,000; for couples, over $32,000.
How can I reduce taxes on Social Security?
Use Roth IRAs and manage retirement withdrawals strategically.
Which state is phasing out Social Security taxes?
West Virginia plans to eliminate these taxes by 2026.
Are Social Security taxes changing this year?
Yes, legislative changes may affect benefits and tax rules.
