When determining your monthly Social Security payment, the most important factors are your retirement age and the amount you contributed during your working years; however, where you live can also influence how much you receive, especially in states that tax Social Security benefits.
While the federal government taxes benefits based on income, nine states have their own rules that can further reduce the amount of benefits you eventually receive.
Most retirees rely on Social Security for a significant portion of their income, so state taxes on these benefits are important to consider. Currently, the majority of US states do not tax benefits.
However, residents in nine states—Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont, and West Virginia—may see their payments reduced due to state-level taxation.
These taxes can have a significant impact on retirees, especially those who rely heavily on Social Security to cover their living expenses. It is critical to understand both federal and state regulations when planning for retirement in these areas.
Individuals with a federal income of more than $25,000 can expect to pay up to 50% of their Social Security benefits in taxes. If your annual income exceeds $34,000, up to 85% of your benefits may be subject to federal taxes. When state taxes are included, the overall reduction can be even greater.
In recent years, some states have changed their approach to taxing benefits. Missouri, Nebraska, and Kansas, for example, used to tax Social Security but now do not. These changes took place over the last two years as part of efforts to make their states more financially appealing to retirees.
However, the rules in the nine states that still offer tax breaks differ greatly, and individual circumstances play a significant role in determining how much tax is owed.
States that tax Social Security benefits
Colorado, for example, taxes residents under the age of 65 who report more than $20,000 in taxable Social Security income on their federal tax returns. This state tax does not apply to retirees over the age of 65.
In Connecticut, Social Security income is taxed if your federal taxable income exceeds $75,000, but there is a cap: only 25% of your Social Security payments can be taxed, and the rate ranges from 2% to 4.5%.
Minnesota provides some relief to lower-income retirees by allowing up to $4,560 of Social Security income to be deducted from taxable income.
However, once an individual’s income exceeds $78,000, this deduction is no longer applicable, so higher-income retirees may face full taxation on their benefits. Other states take similarly varying approaches.
Montana’s tax rates on benefits range from 4.7% to 5.9%, while Vermont’s rates range from 3.35% to 8.75%. In New Mexico, only those with an adjusted gross income of $100,000 or more are taxed on Social Security payments.
Rhode Island, on the other hand, targets people who apply for Social Security before reaching the full retirement age. Utah has one of the lowest income tax thresholds, with Social Security income taxed once it exceeds $45,000.
The complexities of these state rules necessitate that retirees understand the financial landscape in any state where they intend to retire.
According to Alex Beene, a financial literacy instructor at the University of Tennessee at Martin, “Most of these situations have taxation that only comes in if you make more than a certain income in retirement and can even come in phases that eventually dwindle down to nothing over time.”
This gradual phasing of taxes may mean that retirees experience less impact as their income declines in later years.
Furthermore, some states that tax Social Security benefits may have additional policies in place that make them more appealing financially. Beene explains, “For example, some states that do not have a state income tax compensate by imposing a higher sales tax.
It’s the same thing with Social Security taxes, which can make these places less appealing to retirees.”
