For many older Americans, Social Security benefits can make or break retirement. The average retiree collects about $1,657 a month in benefits, according to the Social Security Administration, which can go a long way.
However, depending on where you live, you could potentially lose a large portion of your benefits in taxes. Even after you retire, you may still owe income tax on your Social Security checks. If you live in one of these 13 states, your benefits could be at risk.
How Taxes Affect Your Benefits
Your benefits are subject to both state and federal taxes, and how much you owe — or whether you have to pay Social Security taxes at all — depends on where you live and your income.
Your state income tax will depend on where you live. Fortunately, most states don’t levy Social Security, but there are 13 that do. These states include:
|Montana||Nebraska||New Mexico||North Dakota||Rhode Island|
If you live in one of these states, expect to pay state taxes on your distributions. But even if you live in one of the 37 tax-free states, you’re still not off the hook.
Federal Taxes Can Also Take a Bite From Your Benefits
Your federal taxes are based on a figure called your “combined income.” This number is half your annual Social Security benefit plus your adjusted gross income.
For example, say you earn $20,000 a year in benefits and withdraw $30,000 a year from your 401(k). In this case, your combined income would be $10,000 plus $30,000 or $40,000 per year. Here’s how much of your distributions may be subject to taxes, depending on your combined income:
|Percentage of Your Benefits Subject to Federal Taxes||Combined income for individuals||Combined income for married couples filing jointly|
|0%||Less than $25,000 a year||Less than $32,000 a year|
|Up to 50%||$25,000 to $34,000 per year||$32,000 to $44,000 per year|
|Up to 85%||Over $34,000 per year||Over $44,000 per year|
The good news is that regardless of your income, you don’t pay federal taxes on more than 85% of your benefits. The bad news is, the only way to avoid paying federal taxes is if your combined income is less than $25,000 a year (or $32,000 a year if you’re married).
How to Lower Your Taxes When You Retire?
One strategy for limiting your taxes is to contribute to a Roth IRA. Roth IRA withdrawals do not count towards your combined income. This means that if most of your savings are in this type of account, you can lower your combined income and may not have to pay federal taxes at all.
For example, say you collect $20,000 a year from Social Security, but instead of withdrawing $30,000 a year from your 401(k), you take it from a Roth IRA instead. In this scenario, your combined income would be just $10,000 — and you owe no federal taxes at all.
If your state has a high income tax rate, it may also be worth moving out after retirement. This option isn’t for everyone, though, and think about all the other expenses you might incur if you move to another state, such as property taxes, sales taxes, and general living expenses.
If you depend on Social Security to make ends meet when you retire, it’s wise to make sure you know how taxes can affect your benefits. By taking it into account now, you will be better prepared for your senior years.