Social Security is a vital source of income for millions of retirees. In fact, around one in five baby boomers depend solely on their benefits for their retirement income, according to a 2020 report from the Nationwide Retirement Institute.
However, there’s a chance you might not receive as much as you expect from Social Security. Both state and federal taxes can take a bite out of your benefit amount, and if you’re not prepared for them, you could be in for a surprise in retirement.
How state taxes affect Social Security
Whether you owe state taxes on your benefits will depend on where you live, as each state has its own rules and regulations surrounding Social Security. Fortunately, though, 38 states do not tax benefits at all. The 12 that do tax benefits include:
If you live in one of the 38 states that don’t tax benefits, you’re already off the hook. But if your state isn’t as tax-friendly, you might owe income taxes on at least a portion of your monthly checks.
Again, each state is different. Even among the 12 states that do tax benefits, there may be different laws when it comes to Social Security. It’s best, then, to check your particular state’s laws to determine whether you may be subject to income taxes on your benefits.
Accounting for federal taxes
State taxes are only one part of the equation. No matter where you live, you could also be subject to federal taxes on your benefits.
First, you’ll need to know your provisional income. This is half of your annual Social Security benefit plus your adjusted gross income and any nontaxable interest. So, for instance, if you’re collecting $20,000 per year in benefits and are withdrawing $40,000 per year from your 401(k), your provisional income would be $50,000 per year.
Here’s how much of your benefits could be subject to federal taxes depending on your provisional income:
Percentage of Your Benefits Subject to Federal Taxes
Provisional Income for Individuals
Provisional 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
The positive news is that regardless of your income, no more than 85% of your benefit amount will be subject to federal taxes. However, to get out of federal taxes altogether, your provisional income will need to fall below $25,000 per year (or $32,000 per year for married couples).
How to prepare
For the most part, there isn’t much you can do to avoid taxes on Social Security. If you’re planning on relocating to a different state in retirement, consider how your new location will affect your taxes.
Even if you can’t avoid taxes, you can take steps to prepare for them. By estimating your combined income now, for instance, you’ll have a better idea of what your tax situation might look like in retirement. From there, you can build that expense into your budget, so you’re not caught off guard.
Nobody wants to pay more in taxes, but they’re unavoidable for many retirees. By planning for them now, though, you can head into your senior years as prepared as possible.
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