Even if you retire with a decent amount of savings, chances are you’ll be heavily dependent on the income you receive from Social Security. And if your nest egg isn’t particularly robust, you can bet you’ll need those benefits to pay most of your bills.
Unfortunately, the income you receive is Social Security may not be quite yours to keep. That’s because moderate earners often lose some of their benefits to federal taxes.
In addition, some states levy their own Social Security taxes. And it’s important to know which way to go.
The 13 States That Tax Social Security
Here are the 13 states where you can lose some of your Social Security income on taxes:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
Most of these states do offer an exemption for lower (and in some cases moderate) earners, so retiring in one of these places doesn’t guarantee your benefits will be taxed. But if you’re expecting some pretty generous retirement income, you’ll need to factor in state Social Security taxes if you settle in one of these states.
That said, just because these 13 states tax Social Security income doesn’t mean you have to write them off for retirement. Some of these states offer affordable living expenses, so while you may lose some money in taxes on your benefits, that loss can easily be offset by cheaper housing, transportation, and health care.
Avoiding Federal Social Security Taxes
As mentioned, regardless of which state you retire to, you may face taxes on your benefits at the federal level. Whether that happens depends on your provisional income.
The preliminary income is essentially your non-Social Security income plus half of your annual Social Security income. If you are single and reach that figure of $25,000, distribution taxes will be levied. If you are married, provisional income of $34,000 or more will result in some of your distributions being taxed.
If these income thresholds seem very low, it’s because they are — and also because they hasn’t been updated in years. But there is one step you can take to avoid paying federal taxes on your Social Security income, and that is to turn your retirement savings into a Roth IRA.
Unlike traditional IRAs, Roth IRAs do not provide an immediate tax benefit on contributions. But Roth IRA withdrawals are tax-free and also don’t count in calculating provisional income. So if you’re single and take $40,000 in Roth IRA withdrawals each year during retirement, that $40,000 won’t work against you. And so if your remaining retirement income comes in the form of $20,000 in annual Social Security benefits, you won’t get any federal taxes on your benefits at all.
Now, in that scenario, you may face state taxes on your benefits, depending on where you live. But those taxes can be manageable, especially if you’ve taken other steps to lower your IRS burden as a senior. And while it’s important to know which states tax Social Security, you don’t necessarily have to avoid the states where taxes on benefits apply either. This is especially true if those states offer benefits like proximity to friends and family, where it’s hard to put a price tag on.