Social Security is easily our country's most successful social program. For more than 80 years, Social Security has made guaranteed monthly payouts to eligible retired workers, with over 64 million people today receiving a benefit.
What's more, these payouts are making a meaningful difference in the financial well-being of elderly Americans. Even though the average retired worker benefit is only $1,505.50 a month, as of January 2020, this payout is singlehandedly responsible for pulling more than 15 million retirees out of poverty.
But there's something else Americans get with Social Security that they may not expect: the possibility of being taxed.
Yes, the federal government can tax your Social Security benefit
Back in 1983, the Reagan administration passed the last major overhaul of the Social Security program. The changes made came from both sides of the aisle, with Democrats successfully pushing for increases to revenue generation, and Republicans netting long-term outlay reductions via a gradual increase to the full retirement age. But the biggest change of all was the introduction of the taxation of benefits, which officially took effect in 1984.
The taxation of benefits, as introduced in the Social Security Amendments of 1983, allowed the Internal Revenue Service to apply federal ordinary income tax rates on up to half of an individual's or couple's Social Security benefit, depending on their income. If an individual's or couple's modified adjusted gross income (MAGI) plus one-half of benefits exceeds $25,000 or $32,000, respectively, they would be subject to this tax.
In 1993, under the Clinton administration, a second federal tier of taxation was added. If an individual or couple exceeds $34,000 or $44,000, respectively, using the same MAGI plus one-half benefits formula, then up to 85% of their Social Security benefits are subject to federal ordinary income tax.
What's been a particular bummer about the taxation of benefits is that the income thresholds passed in 1983 and 1993 have never been adjusted for inflation. Therefore, a greater number of seniors are being taxed on their Social Security payouts at the federal level over time. According to nonpartisan senior advocacy group The Senior Citizens League, nearly half of all seniors now pay tax on their benefits.
These states may take a bite of your Social Security income, if given the chance
However, the tax buck doesn't stop with Uncle Sam. Believe it or not, 13 states also tax Social Security benefits to some varied degree. Listed in alphabetical order, these states may take an additional bite out of your Social Security income, if given the opportunity:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
If you don't see your state on this list, be thankful, for you're living in one of the 37 states that doesn't place a tax on Social Security income. This doesn't absolve you from potentially owing federal tax on a portion of your benefits, but you won't have to worry about your state trying to place its hand in the cookie jar, too.
As recently as a couple of years ago, there were four states whose treatment of Social Security income mirrored the federal tax schedule -- Minnesota, North Dakota, Vermont, and West Virginia. At one time, this made these four states among the least friendly to retirees, at least in terms of falling victim to double taxation on your Social Security payout. But times have changed, and all four of these states have initiated new exemptions or thresholds that are designed to not sting as badly as those as the federal level. In fact, West Virginia will be a Social Security tax-free state by 2022.
There are also a handful of states that require seniors to earn quite a lot of money before coming after a percentage of their Social Security income. For example, Missouri allows single filers to earn up to $85,000 in adjusted gross income (AGI), and $100,000 in AGI for couples filing jointly, before the taxation of benefits would kick in. Even then, the Show-Me State allows for partial exemptions for those persons and couples exceeding these income thresholds.
It's a similar story for Rhode Island, which is particularly generous to couples receiving a Social Security payout. Rhode Island adjusts its income thresholds for inflation every year, which placed its generous AGI thresholds at $81,900 for single taxpayers and $102,400 for married couples filing jointly in the 2018 tax year. In other words, you have to earn a lot of money in the Plantation State before being subject to a tax on your Social Security benefit.
While there are, undoubtedly, multiple variables retirees should examine when calling a state home, make sure state-level income thresholds tied to the taxation of Social Security benefits are on the list.