Barron’s senior writer Reshma Kapadia and Barron’s Roundtable discuss how coronavirus upended some people’s retirement plans and what can be done to make up for that lost capital.
Social Security benefits are an important source of retirement income, but you may not get to keep all the money you receive from this entitlement program. In fact, there’s a chance you could be taxed not once but twice on your retirement benefits.
This can happen if your benefits are taxed on the federal and the state level. If you have to pay both the IRS and your local government, you’re being taxed twice on the same dollar. This double tax is the reality for as many as 36.5 million Americans.
The 13 states that tax Social Security
The 36.5 million people who are at risk of double taxation live in the 13 states that currently tax Social Security benefits:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
According to the U.S. Census, the combined population of these 13 states tops 36.55 million people. Not everyone in these states is currently collecting retirement benefits, but most people who live there will receive income from Social Security at some point and thus are at risk of double taxation.
Whether or not residents of these states will face this burden depends on how much they earn, as well as what the rules are in their specific state. But a growing number of residents are likely to be hit with double tax because of the way taxation of benefits works.
On the federal level, benefits become partly taxable once you hit a certain income threshold. Single tax filers are taxed on up to 50% of benefits if their provisional income is between $25,000 and $34,000, and will be taxed on up to 85% of benefits once their provisional income exceeds $34,000.
Married joint filers are subject to tax on up to 85% of benefits with a provisional income between $32,000 and $44,000 and will be taxed on up to 85% of their benefits with an income above this threshold. Provisional income equals half of Social Security benefits, all taxable income, and some nontaxable income.
These thresholds are not indexed to inflation. That means with wages rising and benefits going up accordingly, more people than ever will be subject to federal Social Security taxes in the future even though the buying power of benefits isn’t going up (it’s actually losing ground). In fact, if your income is high enough that your state is taxing your benefits, you’ll almost assuredly also be subject to federal taxation.
Some of the 13 states that tax benefits don’t impose taxes until retirees reach a higher income threshold than the one the IRS applies. That means you may be able to have more than $25,000 or $32,000 in provisional income before you need to worry about being double taxed. But if your earnings are high enough that this happens to you, this could eat into the amount of money you have to enjoy your later years.
If you’re concerned with maximizing your retirement income and are among the 36.5 million people living in a state where you may be hit with state and federal taxes, you need to learn how local tax rules apply to your Social Security. Discovering that your benefits will be taxed both locally and by the federal government may just persuade you that relocating in retirement is your best financial option.