Millions of Americans count on Social Security for a stable income during retirement or while managing a disability. For some, it makes up nearly all of their financial support. While the federal government taxes Social Security benefits based on your income, certain states also apply their own taxes. If you live in one of nine specific states, your monthly benefits could take a noticeable hit due to these additional deductions.
Understanding how these federal and state tax rules work is key to managing your retirement income effectively. Claiming benefits at the right time, budgeting for healthcare, and planning for changes in the system are all part of smart financial preparation. With the Social Security Trust Fund facing long-term challenges, it’s more important than ever to make informed decisions about your benefits and retirement strategy.
How Taxes Affect Your Social Security Payments
Social Security is funded through payroll taxes and plays a major role in supporting Americans over 65, as well as those with disabilities. But your actual payout depends on how much of it is taxed—both by the federal government and, in some cases, your state.
At the federal level, whether you pay tax on your benefits depends on your “combined income.” This total includes your adjusted gross income (AGI), any tax-free interest you receive, and half of your Social Security benefits.
- For individuals:
- If your combined income is $25,000 or less, your benefits aren’t taxed.
- If it’s between $25,000 and $34,000, up to 50% of your benefits could be taxable.
- Over $34,000, up to 85% may be taxed.
- For couples filing jointly:
- Up to $32,000, no tax applies.
- Between $32,000 and $44,000, up to 50% may be taxed.
- Above $44,000, up to 85% of your benefits might be taxable.
Which States Tax Your Social Security?
While most states don’t tax Social Security benefits, nine states do, and the impact depends on where you live and your total income. These states include:
Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont, and West Virginia.
Here’s how some of them handle taxation:
- Colorado: People under 65 can deduct up to $20,000 of taxable benefits. If you’re over 65, you’re generally exempt from state tax on Social Security.
- Connecticut: Taxes apply to up to 25% of your benefits, depending on income.
- Minnesota: Offers some exemptions, but benefits may be partially or fully taxed above certain income levels.
- Montana: Taxes Social Security if it’s included in your federal income. Retirees over 65 may get deductions.
- New Mexico, Utah, and others: Apply their own rules based on AGI and other thresholds.
Living in one of these states could reduce your monthly income from Social Security, so it’s important to factor this into your retirement planning if you’re a resident or considering relocating.
How to Make the Most of Your Social Security
Timing plays a major role in how much you receive from Social Security. You can begin collecting benefits as early as age 62, but doing so will reduce your monthly payout. If you wait until age 70, your benefit grows by about 8% each year you delay, which can add up to a significant increase over time.
Working while drawing benefits can also affect your payments—at least until you reach your full retirement age. If you earn above the annual limit before that age, your benefits may be temporarily reduced. Once you hit full retirement age, there’s no limit on what you can earn without it affecting your Social Security check.
Planning Beyond the Basics
Good retirement planning doesn’t stop with Social Security. Think about how much you’ll need for everyday living and how much will go toward health care—especially since Medicare doesn’t cover everything. A Health Savings Account (HSA) is one smart way to build up savings for medical costs in retirement.
Also, try to pay off high-interest debt before you retire to improve your financial flexibility. This can help stretch your Social Security dollars further.
The Future of Social Security
There’s growing concern about the long-term stability of Social Security. According to current projections, the trust funds that support these payments could run low by 2034. If nothing changes, future benefits might be reduced to around 77% to 81% of what’s currently promised.
To avoid this, potential solutions include raising payroll taxes, delaying the full retirement age, or cutting benefits. Surveys show most Americans would rather pay more in taxes than see their benefits reduced.
As important as financial planning is, don’t forget the emotional and social side of retirement. Many retirees miss the routine and relationships that work provided. Finding new hobbies, staying connected with people, and building a purpose-filled lifestyle can make a big difference in your happiness after you leave the workforce.
