Social Security plays an important role in the financial lives of millions of Americans. For some, it is virtually all of their retirement income; for others it is a significant part of their retirement income; and for still others it’s more of a nice benefit. Regardless of the role Social Security will play in your retirement finances, it is critical to understand the tax implications of your benefits so you can plan accordingly.
The only problem with Social Security benefits is that retirees in ten states can have their benefits taxed at the state level. The better news, however, is that this leaves 40 states with retirees not should be concerned about such taxes.
Retirees in the following states don’t have to worry about state Social Security taxes
Here are the 40 states (along with the District of Columbia) that do not tax Social Security benefits:
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Alabama
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Alaska
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Arizona
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Arkansas
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California
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Delaware
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Florida
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Georgia
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Hawaii
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Idaho
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Illinois
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Indiana
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Iowa
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Kentucky
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Louisiana
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Maine
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Maryland
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Massachusetts
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Michigan
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Mississippi
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Missouri
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Nebraska
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Nevada
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New Hampshire
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New Jersey
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New York
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North Carolina
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North Dakota
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Ohio
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Oklahoma
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Oregon
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Pennsylvania
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South Carolina
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South Dakota
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Tennessee
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Texas
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Virginia
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Washington
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Wisconsin
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Wyoming
An encouraging sign for those who live in one of the ten states that still tax Social Security benefits is that states have slowly but surely begun to eliminate the tax. For example, Missouri and Nebraska have taxed Social Security benefits through early 2024, and West Virginia is on track to eliminate Social Security taxes entirely by 2026.
Social Security tax rules can change every year, so it’s important to stay informed about your respective state’s rules. Most of the changes involve states eliminating the tax, but that doesn’t mean a situation can’t arise where a state that doesn’t charge the tax decides to reinstate the tax. Staying current will keep you from being overwhelmed and unable to plan your finances accordingly.
Avoiding state taxes doesn’t mean you can avoid federal taxes
Regardless of your state’s specific rules around taxing Social Security, federal rules apply to everyone. To determine your tax liability, the IRS uses your “combined income,” which includes your adjusted gross income (AGI), any nontaxable interest (such as municipal bond interest), and half of your annual Social Security benefits.
For example, if your AGI is $60,000, you receive $24,000 in annual Social Security benefits, and you have $1,000 in non-taxable interest, your combined income would be $73,000. Here’s how the IRS may tax your benefits based on combined income and filing status.
An important note is that the percentages above do not indicate how much of your benefits will be taxed, but rather how much will be taxed eligible be taxed. The portion of your Social Security benefits that is eligible to be taxed is added to your other income and then taxed at your regular income tax rate.
For example, imagine one filer has a combined income of more than $34,000, receives $20,000 annually in Social Security, and is in the 22% tax bracket. If 85% of their benefits are taxable ($17,000), $17,000 would be added to their taxable income and taxed at 22%, resulting in $3,740 owed on their Social Security benefits.
Remember: changes to social security are common, and the best thing you can do is make sure you are as informed as possible about the rules relevant to your personal situation. The last thing you want is to be faced with an unexpected tax bill.
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40 States That Don’t Tax Social Security Benefits was originally published by The Motley Fool
