If you have done your homework leading into retirement, you probably already know that Social Security benefits may be subject to federal taxes under certain circumstances. Did you know that some states also impose taxes on Social Security?
Currently there are thirteen states that impose at least some tax on the benefits of Social Security – Connecticut, Colorado, Utah, New Mexico, Nebraska, Kansas, Rhode Island, Missouri, Minnesota, Vermont, Montana, West Virginia and North Dakota. The last five of these states determine Social Security taxes using the same formula as the federal government. Federal rules require you to determine your combined income, defined as your adjusted gross income (AGI) added with nontaxable interest, and then added again with one-half of your Social Security benefits. If this combined income falls between $25,000 and $34,000 for singles and $32,000 to $44,000 for couples filing jointly, up to 50% of benefits may be taxed. Above those levels, as much as 85% of Social Security benefits may be taxed.
“The thresholds where you start getting tax paid on Social Security benefits haven’t changed in well over 20 years,” says Betterment Head of Tax Eric Bronnenkant. “Assuming that everything else in your life rises with inflation, then more and more people are having a greater percent of their Social Security subject to tax and are in an exceptionally higher tax bracket. There haven’t been any changes, even with the new tax law, about raising the thresholds. It’s unfortunate that they haven’t been adjusted at all in a really long time.”
Other states set various exemptions and thresholds to reduce the tax impact on retirees, although a few simply tax Social Security benefits without any form of exemption.
New Mexico allows a deduction of $8,000 in retirement income to seniors with an AGI of $28,500 or below for single filers or $51,000 or below for married couples filing jointly. A $2,500 deduction is available for Social Security beneficiaries under age 65 with AGI limits of $36,667 for single filers and $55,000 for couples.
Colorado allows a generous deduction of $24,000 in retirement income for filers age 65 and above and a $20,000 deduction for filers age 55-64. Married couples have an even better deal, as each spouse can claim the individual deduction.
Kansas exempts all Social Security benefits from taxation as long as your federal AGI is no more than $75,000 for both individuals and married couples, while Missouri extends that exemption limit to $85,000 AGI ($100,000 for joint filers). Rhode Island has the same $100,000 exemption limit for couples but a lower AGI limit of $80,000 for singles. Connecticut’s full exemption kicks in at an AGI of $50,000 for single filers and $60,000 for joint filers.
Nebraska taxes all Social Security benefits as part of your collective income according to one of four tax brackets, with the high bracket being 6.84% for single filers at incomes of $29,590 or above and couples with incomes of $59,180 or above.
Utah does not exempt any Social Security income from state taxation. Your Social Security benefits will be lumped in with your AGI and taxed at the flat rate of 5%. Low-income retirees may be able to qualify for a tax credit that can partially neutralize some of this tax, but the credit phases out at $25,000 for single filers and $32,000 for married couples filing jointly.
Social Security benefits may not be the form of retirement taxation that should concern you most. Other forms of retirement income such as pensions, IRAs, 401(k) plans and railroad retirement benefits may have taxation variations by state. Check with each state’s Department of Revenue or similar agency for details.
You certainly can save money by retiring to a state that doesn’t tax Social Security – but in the grand scheme of things, there are far more important factors in choosing your retirement location. Cost of living, activities, healthcare facilities, transportation options, friends and family are all examples that should take higher priority. However, if you can’t decide between two equally appealing options, feel free to use state Social Security taxation as your tiebreaker.
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