Not only are taxes one of the biggest expenses you’ll face in retirement, but figuring out what you will and won’t get taxed on can create a major headache.
Adding to the challenge are the special rules around Social Security taxation. Many near-retirees mistakenly believe Social Security income is taxed just like regular income or withdrawals from a retirement account. In fact, the federal government uses a special formula to determine what portion of your Social Security benefits, if any, you’ll owe taxes on. And 38 states (soon to be 40) won’t tax Social Security at all.
Read on to see how the federal government taxes Social Security income, the 38 states that won’t tax benefits, and how you can reduce your taxes in retirement.
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How the federal government determines Social Security taxes
The IRS uses a metric called “combined income” to determine what portion of your Social Security income is subject to federal income taxes. Combined income is the sum of your adjusted gross income, non-taxable interest income, and half your Social Security income.
When your combined income exceeds a certain threshold, a portion of your Social Security benefits are added to your taxable income. That portion could be anywhere between 0% and 85%, depending on your situation.
The following table details what portion of your Social Security income the federal government will tax.
| Taxable Portion of Social Security | Single Filer Combined Income | Joint Filer Combined Income |
|---|---|---|
| 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% | Greater than $34,000 | Greater than $44,000 |
Data source: Social Security Administration.
Determining how much of your Social Security benefits are subject to federal income tax can be tricky, especially if you’re considering additional retirement account withdrawals or taking capital gains. A good financial planner will help you come up with an effective tax strategy factoring in the impact of combined income on Social Security taxes.
The 38 states that don’t tax Social Security benefits
While you can’t avoid federal taxes on Social Security if your combined income exceeds the above thresholds, you can avoid state taxes.
12 states tax Social Security in some cases, with each state having different rules for how those taxes are calculated. But 38 states (and the District of Columbia) won’t tax your Social Security income at all under any circumstances.
Here are the 38 states that don’t tax Social Security benefits:
- Alabama
- Alaska
- Arizona
- Arkansas
- California
- Delaware
- District of Columbia
- Florida
- Georgia
- Hawaii
- Idaho
- Illinois
- Indiana
- Iowa
- Kentucky
- Louisiana
- Maine
- Maryland
- Massachusetts
- Michigan
- Mississippi
- Nevada
- New Hampshire
- New Jersey
- New York
- North Carolina
- North Dakota
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- South Carolina
- South Dakota
- Tennessee
- Texas
- Virginia
- Washington
- Wisconsin
- Wyoming
Starting next year, Missouri will exempt all taxpayers from Social Security income taxes regardless of total income. Nebraska will join the group in 2025 after passing a law repealing its Social Security tax earlier this year.
How to save on taxes in retirement without moving
You don’t have to move to a new state to save on taxes in retirement. So much of retirement is personal, and the cost of living in some states could easily make up for the increased taxes you’ll pay for living there. More importantly, laws are constantly changing, and you never know when a state might change its policy on Social Security taxation. Indeed, many Social Security recipients don’t pay state income taxes on their benefits even if they live in the 12 states that tax some of their residents.
That said, there are some tried-and-true strategies for reducing taxes in retirement and keeping more of your Social Security benefits. These work in any state and can save you money at the state and federal levels.
The first strategy is straightforward. Save money in a Roth retirement account like a Roth IRA. Roth accounts require investors to pay taxes upfront, but withdrawals don’t count toward taxable income as long as you’re at least 59 1/2. That means they have zero impact on your combined income, which determines what percentage of your benefits get taxed. So, a Roth account could have a double tax advantage in retirement if it keeps your Social Security income tax-free.
If you’re already nearing retirement, though, and you have a lot of money in traditional retirement accounts, you still have options. You can withdraw a significant sum from your retirement accounts in the first few years of retirement before you start collecting Social Security. You can use the money for living expenses or perform a Roth conversion, which moves money from a traditional account to a Roth. While you’ll owe a lot of taxes up front, the long-term tax savings can be worth it.
Lastly, consider the special tax treatment for capital gains. Long-term capital gains (achieved by holding a security for more than one year) can have a tax rate as low as 0%. If you can lock in a 0% tax rate on capital gains before you claim Social Security, you may be able to avoid taxes on your benefits later.
You may want to consult a professional tax planner for your options to reduce your taxes in retirement. But you don’t necessarily have to move to one of the above states to do so.
