9 States to Tax Social Security Benefits Starting in January: Social Security benefits are a crucial source of income for retirees, offering financial support during their golden years. While many are familiar with the federal taxation of these benefits, it’s important to be aware that some states also impose their own taxes on Social Security payments. This guide explores why Social Security benefits are taxed, identifies the states that tax them, and offers strategies to reduce the tax burden.
Understanding Social Security Taxes
Social Security benefits are treated as income by the IRS, which means they can be subject to federal taxes depending on your overall income. Factors such as wages, dividends, and other earnings play a role in determining your tax liability.
Federal Tax Guidelines
The IRS sets thresholds based on your combined income, which is calculated as your adjusted gross income (AGI) plus non-taxable interest and half of your Social Security benefits:
- Individual Filers
- Combined income between $25,000 and $34,000: Up to 50% of benefits may be taxable.
- Combined income above $34,000: Up to 85% of benefits may be taxable.
- Joint Filers
- Combined income between $32,000 and $44,000: Up to 50% of benefits may be taxable.
- Combined income above $44,000: Up to 85% of benefits may be taxable.
States That Tax Social Security Benefits
While most states do not tax Social Security benefits, nine states impose their own taxes. If you’re planning your retirement, here are the states to watch out for:
- Colorado
- Connecticut
- Minnesota
- Montana
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
State-Specific Considerations
- Income Exemptions: Many states exempt Social Security benefits from taxation if your income is below a certain threshold. For instance, New Mexico does not tax benefits for individual filers with an AGI under $100,000.
- West Virginia’s Phase-Out: West Virginia is in the process of phasing out its Social Security tax entirely, with full elimination planned by 2026.
How to Minimize Taxes on Social Security
With strategic planning, retirees can reduce or even avoid taxes on their benefits. Here are some practical approaches:
- Use Roth IRAs
Contributions to a Roth IRA are made with after-tax dollars, and withdrawals are tax-free. Since Roth IRA withdrawals don’t count as part of your combined income, they can help lower the taxable portion of your Social Security benefits. - Strategic Withdrawals
Plan withdrawals from traditional IRAs or 401(k)s before claiming Social Security benefits. By reducing taxable income in retirement, you can avoid crossing thresholds that result in higher taxes on Social Security. - Leverage State Exemptions
If you live in a state that taxes Social Security, research their income exemption rules. Reducing your adjusted gross income could help you qualify for exemptions, minimizing or eliminating state taxes.
Upcoming Changes to Social Security
Social Security is undergoing scrutiny due to concerns about its financial sustainability. Potential legislative changes could include:
- Eligibility Adjustments: Changes to age or income requirements for benefits.
- Benefit Reforms: Modifications to how benefits are calculated.
- Pension Offsets: Updates to rules for beneficiaries receiving public pensions.
Retirees should stay informed about these developments to understand how their benefits may be affected.
Final Takeaway
Knowing how Social Security benefits are taxed is critical for optimizing your retirement income. While federal taxes are unavoidable for many, careful planning can help reduce the impact of state taxes. By considering where you retire and employing strategies such as Roth IRA contributions and thoughtful withdrawal planning, retirees can preserve more of their benefits and enjoy a more secure financial future.