Social Security benefits, a cornerstone of U.S. retirement, are increasingly subject to federal taxation as income thresholds remain unadjusted for inflation, impacting retiree disposable income. While most states exempt these benefits, nine states continue to impose taxes, though this trend is gradually reversing. This evolving tax environment creates regional disparities in retiree financial health and underscores the critical need for sophisticated tax planning among individuals, potentially influencing demand for tax-efficient investment products and services.
Social Security is the foundation for most Americans' retirement plans. Without that benefit program, nearly 4 in 10 Americans 65 and older would have incomes that fall below the federal poverty line, according to the Center on Budget and Policy Priorities. The difference between keeping all of their benefits and losing even a portion of them can be massive for those households. And even for those who enter retirement on a solid financial footing, Social Security usually plays a key role in their budgets. Unfortunately for people living in nine states, depending on their incomes, there's a chance they'll owe state income taxes on a portion of their Social Security benefits this year. Here's what you need to know. How are Social Security benefits taxed? Anyone collecting Social Security ought to know the details of how the federal government taxes their benefits. The federal government will tax a portion of your Social Security benefits if your "combined income" exceeds certain thresholds. Combined income is a special metric used just to determine Social Security taxes. It's equal to the sum of half your Social Security income, your adjusted gross income, and any untaxed interest income. Benefits are subject to taxation based on the following table. | Taxable Portion of Benefits | Combined Income, Individual | Combined Income, Married Filing Jointly | |---|---|---| | 0% | Less than $25,000 | Less than $32,000 | | Up to 50% | $25,000 to $34,000 | $32,000 to $44,000 | | Up to 85% | $34,001 and up | $44,001 and up | You might look at those thresholds and think they're quite low, and you'd be right. Congress has not updated them for inflation in over 30 years, and there's no plan in Washington to adjust them in the future. But as benefits receive cost-of-living adjustments almost every year, more and more retirees are paying taxes on some of their Social Security. Careful planning could help you avoid a surprise tax bill come April. Retirees collecting Social Security need to consider how additional capital gains or retirement account withdrawals will impact their overall tax bill. But retirees in nine states have an extra consideration to worry about. 9 states that tax Social Security Most states don't tax Social Security benefits, and the number that do has been dropping. Kansas, for example, just eliminated its tax on Social Security earlier this year, effective for the 2024 tax year. But nine states still impose some income taxes on some people's benefits. If you live in one of these states you should take the extra time to do some research on your personal situation or consult a professional to learn if there are ways to reduce your tax bill. Here are the basics for each state. Colorado: Taxpayers under 65 with more than $20,000 in taxable benefits on their federal income tax return will owe state income taxes on the amount above that threshold. Retirees 65 or older are exempt from state taxes on Social Security benefits. The state tax rate is 4.4%. Connecticut: The portion of your Social Security income that is taxed at the federal level may be subject to state taxes in Connecticut if your adjusted gross income exceeds $75,000 for individuals or $100,000 for joint filers. However, the amount subject to state taxes is limited to 25% of your benefits, regardless of what percentage is taxed federally. The tax rate ranges from 2% to 4.5%. Minnesota: Taxpayers can deduct up to $4,560 as individuals or $5,840 for married couples filing jointly in Social Security benefits from their taxable incomes. That deduction begins getting reduced for residents with combined incomes above $69,250 for individuals or $88,630 for married couples, and phases out completely at combined incomes of $78,000 or $100,000, respectively. The income tax rate ranges from 6.8% to 9.85%. Montana: Any portion of your Social Security income that is taxed at the federal level is also subject to state income tax in Montana. The tax rate ranges from 4.7% to 5.9%. New Mexico: Taxpayers with adjusted gross incomes exceeding $100,000 for individuals or $150,000 for married couples filing jointly will owe state taxes on any Social Security income that is also taxed at the federal level.https://www.tax.newmexico.gov/social-security-income-tax-exemption/ The state tax rate ranges from 4.9% to 5.9%. Rhode Island: Taxpayers below their full retirement age as defined by Social Security with adjusted gross incomes above certain thresholds will owe taxes on any portion of Social Security income that is also taxed at the federal level. Those thresholds were $101,000 for individuals or $126,250 for married couples filing jointly in 2023, but they get adjusted for inflation each year. The tax rate ranges from 4.75% to 5.99%. Utah: Taxpayers with adjusted gross incomes exceeding $45,000 for individuals or $75,000 for married couples filing jointly will owe taxes on any Social Security income that is taxed at the federal level. People below those thresholds qualify for a credit to offset the taxes. The tax rate is 4.65%. Vermont: Taxpayers with adjusted gross incomes above $50,000 for individuals or $65,000 for married couples filing jointly will owe income taxes on at least a portion of any Social Security income included on their federal income tax return. The tax rate ranges from 3.35% to 8.75%. West Virginia: 65% of any Social Security income included on your federal income tax return is subject to state income tax in West Virginia. However, those taxes are being phased out. In 2025, 35% will be taxable, and starting in 2026, the state will stop taxing benefits. The tax rate ranges from 2.55% to 5.525%. Don't make decisions about where to retire based entirely on taxes While retirees in those nine states may be subject to extra taxes, it's important to consider the big picture in retirement. Hopefully, you'll have a long retirement, and states' tax policies can change drastically over time. Many have taken steps to reduce or eliminate their taxes on Social Security in just the past few years. More important considerations for picking where you'll settle down in retirement may include the cost of living and what a community has to offer. Those factors can have much bigger impacts on your ability to live on your own terms in retirement than a few dollars worth of state taxes. That said, there are many different ways to reduce your tax bill in retirement without changing where you live. Planning in advance, effectively using Roth retirement accounts, and managing your capital gains and losses can help avoid taxes and keep more of your retirement income for yourself. The $22,924 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $22,924 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies. View the "Social Security secrets" › The Motley Fool has a disclosure policy. The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc. The federal taxation of Social Security benefits is creating a growing, inflation-driven tax burden on retirees due to income thresholds that have remained static since their inception over 30 years ago. As cost-of-living adjustments increase nominal benefits, more recipients are pushed past the low "combined income" thresholds of $25,000 for individuals and $32,000 for joint filers, subjecting up to 85% of their benefits to federal tax. This creates a long-term headwind for retiree disposable income. In contrast, a diverging trend is occurring at the state level, where the number of jurisdictions taxing these benefits is declining, as evidenced by Kansas recently eliminating its tax and West Virginia phasing its tax out by 2026. However, nine states, including Minnesota, Vermont, and New Mexico, continue to levy taxes on Social Security, creating significant regional disparities in the net income of retirees. This complex and evolving tax landscape underscores a structural demand for sophisticated retirement and tax planning services, as well as for tax-advantaged investment vehicles.
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