As of December, 61.9 million people were receiving a monthly stipend from Social Security, and almost 69% of these recipients were retired workers. Of these seniors, more than three out of five rely on their monthly payout to account for at least half of their income. It's simply that important to the financial well-being of our nation's retired workforce.
But America's most important social program may have an unpleasant surprise in store for seniors in the years and decades to come.
Who's ready to pay federal tax on their Social Security benefits?
The biggest shock for most future beneficiaries is the likelihood that they'll wind up paying at least some tax on their Social Security benefits. Despite having paid into the program via the payroll tax throughout their working years, Social Security benefits also become taxable at the federal level, up to a certain extent, based on your earned income.
In 1983, the Reagan administration passed the last sweeping overhaul of Social Security. With the program running a long-term actuarial deficit, the federal government passed a series of measures designed to boost revenue and cut costs. Among them included the adoption of the federal taxation of Social Security benefits. Essentially, single taxpayers with more than $25,000 in adjusted gross income (AGI), and couples filing jointly earning over $32,000 in AGI, who are currently receiving benefits, can have 50% of their benefits exposed to federal ordinary income taxes.
In 1993, the Clinton administration added another tier of federal taxation. It allowed 85% of Social Security benefits to be exposed to federal income-tax rates if a single beneficiary earned more than $34,000 in AGI, or if a couple filing jointly earned over $44,000 in AGI.
When first introduced, this tax was designed to affect around one in 10 senior households. However, because the income thresholds haven't been adjusted for inflation since they were introduced nearly 35 years ago, approximately 56% of senior households receiving benefits are now on the line for some form of federal taxation.
A quarter of U.S. states tax Social Security benefits, too
I wish I could say that were all, but it's not. There are 13 states that tax Social Security benefits, too.
In alphabetical order, these states are:
Four states with generous Social Security tax exemptions
Of course, the list of 13 states that tax Social Security has quite the bifurcation of its own. For instance, Minnesota, North Dakota, Vermont, and West Virginia all mirror the tax schedule of the federal government. Meanwhile, four of the aforementioned states offer generous exemptions despite taxing Social Security income.
Missouri: No state that taxes Social Security benefits offers more lucrative exemptions than Missouri. The Show Me State won't even consider touching a dime of your Social Security benefits via taxation unless you've earned more than $85,000 in AGI as a single taxpayer, or $100,000 in AGI as a couple filing jointly. What's more, even if taxpayers exceed these limits, partial exemptions may still apply. Translation: Most beneficiaries won't owe any extra tax.
Rhode Island: The Ocean State is nearly as generous as Missouri when it comes to state-level Social Security tax exemptions. Single filers can earn up to $80,000 in AGI and get a free pass, while couples filing jointly can earn up to $100,000 in AGI. Though you'd owe federal tax on your benefits at this level, Rhode Island wouldn't take a red cent.
Kansas: The Sunflower State is yet another relatively welcoming home for retirees. Social Security beneficiaries are able to earn up to $75,000 in AGI without owing any additional tax to the state. With a median annual household income of roughly $46,200 for those over age 65, it suggests most seniors won't be subject to this state tax.
Connecticut: Last, but not least, the Constitution State tends to give Social Security recipients the benefit of the doubt when it comes to tax time. Though not as generous as the previous three states, Connecticut still exempts individual taxpayers with less than $50,000 in AGI, and married couples filing jointly with under $60,000 in AGI, from owing state-level tax. Even though Connecticut has the highest average income in the U.S., its per capita income of $41,087 in 2016 suggests that plenty of folks are getting a free pass.
In short, pay attention to where you retire, because no one wants to have to pay state andfederal tax on their Social Security benefits if they don't have to.
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