Income is the most important aspect of retirement planning and Social Security is the largest source of income for most retirees. As you approach your golden years, it is wise to take stock of your money needs and sources of income. That planning will help you determine the best age to receive Social Security benefits, how to spend your 401(k) or IRA, and how to structure your retirement payouts. You need to understand the tax implications of retirement income decisions you make, so it’s important to figure out how your state taxes Social Security.
States Without Income Tax
There are seven states that have no income tax at all. If you live in one of these, you will receive your state-level Social Security benefits tax-free. These states are:
- south dakota
This is obviously attractive to anyone earning wages or receiving passive income, but it can be especially useful for retirees with a fixed budget. The average household spends about $48,000 a year on retirement, so 5% to 10% saved on state income taxes can easily keep an extra $400 in your pocket each month.
There are two more states that do not tax earned income or Social Security benefits:
- New Hampshire
While it’s great that Tennessee and New Hampshire don’t tax your Social Security benefits, they both still tax dividends and interest. That’s relevant to the roughly half of retirees who have investment accounts that generate income.
States that exempt Social Security from income tax
There remain 41 states that collect income tax revenues, but most of them allow residents to deduct Social Security benefits from their taxable income. If you live in one of these states, your Social Security is not taxed.
- New Jersey
- New York
- North Carolina
- south carolina
In addition, residents of the District of Columbia can deduct Social Security from their taxable income.
There is really no reason to discredit tax-free income, but residents of the above states should also consider other forms of taxation. Most states collect property taxes, with New Jersey, Illinois, New Hampshire, Connecticut, Vermont, and Texas among the highest.
Sales tax is another popular source of income for many states, which is relevant if all of your retirement income is spent on consumption. California residents pay a 7.25% tax on non-essential purchases. In Indiana and Mississippi it is 7%. Several other states charge between 6% and 7%. Sales tax is generally not applied to groceries, clothing, medical services and basic necessities, so keep that in mind when building a retirement plan.
It is important to consider the impact of various taxes when preparing a budget and assessing the purchasing power of your retirement income.
States Taxing Social Security
That leaves us with the 13 states that don’t deduct Social Security from taxable income.
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
Before residents of these states get too mad at their retirement lifestyles going out the window, know that most of them do offer some breaks. Many of them allow retirees to fully deduct Social Security income as long as their income does not exceed a certain level. Those thresholds can be as high as $100,000 for married couples in a few of those states. Most people don’t actually pay income tax on their Social Security benefits, even in the places that don’t offer general exemptions.