Some things in life are guaranteed: death, taxes, and being let down by your favorite sports team. You can do your best to delay the first one, and some are much luckier than others with their sports teams of choice, but taxes always seem to hang around.
Even after retirement eliminates income tax on your salary, some taxes still follow you well into retirement. Thankfully, some retirees will be relieved by their state's rules regarding retirement income. Let's see if it applies to you.
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Which states tax Social Security income?
Social Security is funded by payroll taxes for virtually all Americans throughout their careers. Unfortunately, that doesn't mean you're exempt from paying taxes on your Social Security retirement benefits, though some state-level exceptions exist. As it stands, nine states tax Social Security benefits:
- Colorado
- Connecticut
- Minnesota
- Montana
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
The good news is that this list has gotten smaller every year or so, and more states have plans to remove their Social Security retirement taxes. For example, Missouri and Nebraska taxed Social Security until the start of this year, and Kansas eliminated its tax in June, retroactive to Jan. 1.
If you live in or plan to retire in one of the nine states above, it's important to check your state's specific rules. There is no universal method for taxing Social Security; states decide their own criteria for taxation.
Rhode Island, for instance, exempts single filers who have reached full retirement age and are making less than $101,000 and those filing jointly making under $126,250. On the other hand, retirees at least 65 years old in Colorado can deduct all of their Social Security benefits from their state income tax, while those 55 to 64 can deduct up to $20,000 in retirement income.
What states tax income from retirement accounts
Ideally, you'll have income from retirement accounts, so it's helpful to be aware of potential taxes you could face.
In most cases, income from retirement accounts like 401(k)s and traditional IRAs is taxed like your regular income. Roth IRA withdrawals aren't taxed as long as you're 59 1/2 years old and have had the account for a minimum of five years, so you don't have to worry about those withdrawals if you meet these qualifications.
Some retirees are luckier when it comes to retirement income. In addition to the states that don't have a state income tax at all, Illinois, Iowa, Mississippi, and Pennsylvania do not tax income from retirement accounts or pensions. For retirees in the other states, prepare for withdrawals from these accounts to be taxed.
Regardless of your state's tax rules, federal taxes still apply
Even those in the clear from taxes on Social Security and retirement account withdrawals on the state level are subject to federal taxes. Withdrawals from retirement accounts -- excluding Roth versions -- are typically taxed like ordinary income.
Regarding Social Security, the IRS decides your tax obligation by your combined income. This includes half of your yearly Social Security benefit, your adjusted gross income, and any interest you receive that's nontaxable (like certain bonds). The IRS uses this amount to decide what percentage of your Social Security benefits are taxable.
| Percentage of Taxable Benefits Added to Income | Filing Single | Married, Filing Jointly |
|---|---|---|
| 0% | Less than $25,000 | Less than $32,000 |
| Up to 50% | $25,000 to $34,000 | $32,000 to $44,000 |
| Up to 85% | More than $34,000 | More than $44,000 |
Source: Social Security Administration.
The amount of your Social Security benefits that are eligible to be taxed is added to your income for the year and taxed at your regular tax rate. It might sound confusing, but here's how it works:
Say you're married and filing jointly, receiving $24,000 in annual Social Security benefits, with a combined income of $45,000. This doesn't mean you'll pay 85% tax ($20,400). Instead, $20,400 could be added to your annual income and taxed like any other income. If your tax rate is 22%, for example, you could owe up to $4,488 extra.
Retirees shouldn't expect to give up a large chunk of their Social Security or retirement income to taxes. More than anything, the important part is knowing what tax obligations to expect so you're not caught off guard and miscalculate your retirement finances.
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