4 Problems You Could Face if You Don’t Save Enough for Retirement
It's recommended that everyone saves for retirement throughout their career. Find out how your retirement could be affected if you don't save enough.
Social Security benefits can go a long way in retirement, especially if your savings are falling short. But there’s a sneaky expense that could take a bite out of your monthly checks: taxes.
Even in retirement, it’s tough to escape taxes. Your Social Security benefits may be subject to both state and federal income taxes, and if you’re not prepared for them, they could throw a wrench in your retirement plans.
Exactly how much taxes will affect your benefits will depend on your situation, and not everyone will be subject to them. Here’s what you can expect.
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Preparing for state taxes
Whether you owe state income taxes on your benefits will depend on where you live, but the good news is that 38 states don’t tax Social Security at all. There’s a good chance, then, that you’re already in the clear.
The 12 states that do tax benefits include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia.
However, even among the states that tax Social Security, most have exclusions based on income or age.
In Colorado, for example, Social Security benefits are exempt up to $24,000 once you reach age 65. Kansas also exempts Social Security if your adjusted gross income is below $75,000 per year. And Nebraska is slowly phasing out taxes on benefits, with all Social Security being exempt by 2025.
If you’re unsure whether you’ll owe state taxes on your benefits, it’s best to check your state’s regulations to see if you’re eligible for any exemptions.
Don’t forget about federal taxes
State taxes are only half of the equation, and regardless of where you live, you could also owe federal taxes on your benefits.
Your federal taxes are determined by a figure called “provisional income.” Your provisional income is half of your annual Social Security benefit plus your adjusted gross income and any nontaxable interest.
So, for instance, say you’re collecting $20,000 per year in benefits and withdrawing $30,000 per year from your 401(k). In this scenario, your provisional income would be $40,000 per year. Here’s how much of your benefits could be subject to federal taxes based on your provisional income:
| Percentage of Your Benefits Subject to Federal Taxes | Provisional Income for Single Filers | Provisional Income for Married Couples Filing Jointly |
|---|---|---|
| 0% | Under $25,000 per year | Under $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 |
Source: Social Security Administration
If these numbers seem low, it’s because they are. The income limits for federal taxes haven’t been updated since 1984, when Social Security first became taxable. As the general cost of living increases, more seniors will owe federal taxes on their benefits if these limits remain unchanged.
How to get out of taxes on your benefits
It’s hard to avoid Uncle Sam, but there is a loophole that can help you get out of federal taxes on your benefits: invest in a Roth retirement account.
Withdrawals from a Roth IRA or Roth 401(k) don’t count toward your provisional income. If the majority of your savings are in this type of account, you could reduce your provisional income enough to lower or even eliminate federal taxes on your benefits.
So, for example, if you were to withdraw $30,000 per year from a 401(k) while collecting $20,000 per year from Social Security, your provisional income would be $40,000 per year, and you’d owe taxes on up to 85% of your benefit amount.
But say you were to withdraw that money from a Roth IRA instead, all other factors remaining the same. Your provisional income would be just $10,000 per year, and you wouldn’t be subject to federal taxes at all.
Taxes can be complex and confusing, but it pays to understand how they’ll affect your benefits. When you have an idea of what to expect when it comes to state and federal taxes on Social Security, you can head into retirement as prepared as possible.
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What it amounts to is we are being double taxed on social security .