At a federal level, all Social Security payments are included as part of your income and are thus taxed accordingly. However, some may be surprised to learn that individual states also reserve the right to also tax your Social Security payments. While the majority of states do not do this, nine states do tax tax your Social Security payments in addition to your federal tax. If you are a current beneficiary of Social Security payments, these are the nine states you should think twice about before moving to if you want to maximize your Social Security benefits.
Why are Social Security benefits taxed?
When beneficiaries start to receive their Social Security benefits, the government still counts this as your income. This means that you are still liable to pay income tax if your benefits cross over a certain threshold. Approximately 40% of beneficiaries who receive Social Security pay income tax. This is often not due to the Social Security alone, but because the beneficiary has other income sources which still makes them liable to pay income tax.
The IRS stipulates the following income criteria must be met for you to be liable to pay income tax on your Social Security benefits:
- File a federal tax return as an “individual” and your combined income* is
- Between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits.
- More than $34,000, up to 85% of your benefits may be taxable.
- File a joint return, and you and your spouse have a combined income* that is
- Between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits.
- More than $44,000, up to 85% of your benefits may be taxable.
Which states to watch out for
If you are close to retiring and are thinking about relocating, these states are the ones you should watch out for as in addition to federal income tax, they also charge state income tax on your benefits:
- Colorado
- Connecticut
- Minnesota
- Montana
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
However, these states do have exceptions from the state tax if you earn below a certain income. New Mexico has the highest threshold, where you only pay tax on your benefits as an individual filer if your total adjusted gross income exceeds $100,000. Additionally, West Virginia is currently in the process of phasing out state income tax on Social Security payments where by 2026 they will no longer tax your benefits.
How to reduce the amount of tax you pay on your benefits
There are many strategies you can take to reduce the amount of tax you owe on your Social Security benefits. One way is to make contributions for your retirement to a Roth IRA account. This is because contributions to Roth IRAs are made after-tax and withdraws from them are not counted towards your total gross taxable income. This means your gross taxable income is lowered and hence the amount of tax you owe on your benefits is lowered.
An additional strategy is to make strategic withdrawals from retirement accounts before you retire. By carefully planning when and how much to withdraw from your retirement accounts, you can potentially reduce your future tax liabilities, maintain more control over your retirement income, and maximize your financial security in retirement.
This year is expected to bring significant changes for Social Security, as ongoing concerns about the program’s financial stability and sustainability continue to drive legislative action. With discussions surrounding the program’s future funding, beneficiaries can expect potential reforms that could affect everything from eligibility criteria to benefit calculations. Additionally, new legislation will come into action this year, expected to change the amount of benefits certain beneficiaries receive if they also draw from a public pension.
