1 Social Security Surprise That Could Cost You in Retirement

Social Security benefits can make retirement far more affordable, especially if your retirement savings are falling short. The average retiree collects over $1,600 per month in benefits, according to the Social Security Administration, which can go a long way in retirement.

However, there’s one sneaky expense that could take a bite out of your benefits. And if you’re not prepared for it, it could throw off your budget in retirement.

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How taxes affect your Social Security

Unfortunately, even in retirement, you may not be able to get away from taxes. Your Social Security benefits may be subject to both state and federal income taxes, and it’s wise to prepare for them now so they don’t take you by surprise down the road.

State taxes will depend on where you live, as each state has different regulations as to whether benefits are taxed.

The good news is that 38 states do not tax Social Security at all. The 12 that do include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia. (North Dakota formerly taxed benefits as well, but as of 2021 has excluded Social Security from taxation.)

Whether you owe federal taxes will depend on a factor called your “combined income.” This is your adjusted gross income (such as 401(k) withdrawals) plus half of your annual Social Security benefit amount.

Percentage of Your Benefits Subject to Federal Taxes
Combined Income for Individuals
Combined Income for Married Couples Filing Jointly
Less than $25,000 per year
Less than $32,000 per year
Up to 50%
$25,000 to $34,000 per year
$32,000 to $44,000 per year
Up to 85%
More than $34,000 per year
More than $44,000 per year

Data source: Social Security Administration.

Fortunately, you won’t pay federal taxes on more than 85% of your benefit amount, regardless of your income. However, the only way to avoid federal taxes altogether is if your combined income is less than $25,000 per year (or $32,000 per year for married couples).

How to reduce your Social Security taxes

In many cases, Social Security taxes are simply something retirees have to live with and prepare for. Sometimes, though, there are steps you can take to avoid them.

If you live in a state that does tax Social Security, consider whether it’s worthwhile to relocate to a more tax-friendly state. Of course, there are plenty of other factors to think about before you move. But in some cases, relocating could help you save a lot of money.

Contributing to a Roth IRA could also reduce your federal taxes, because Roth IRA withdrawals do not count toward your combined income. If the majority of your income in retirement is from this type of account, then you could potentially reduce your combined income enough to lower or even eliminate federal taxes on your benefits.

Taxes may have a larger effect on your Social Security benefits than you may think. However, with the right strategy, you can head into retirement as prepared as possible.

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