Deciding Where to Retire: Finding a Tax-friendly State to Call Home
Wolters Kluwer Outlines State Tax Considerations for Retirees
(NEW YORK, NY, January 2018) — Whether you're looking to stay put, seeking out adventure or just hoping for a warmer climate in your golden years, how much of your retirement income goes to taxes depends not just on how much income your nest egg earns, but also on where you choose to live. A little pre-retirement homework on state tax treatments of retirement benefits and other financial factors can be a key step in deciding where to establish new, post-career roots. Specific factors to consider include:
- State taxes on retirement benefits
- State income tax rates
- State and local sales tax
- State and local property taxes
- State estate taxes
Taxability of Retirement Benefits Varies State to State
Currently, seven states do not tax individual income – retirement or otherwise: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.
Two other states – New Hampshire and Tennessee – impose income taxes only on dividends and interest.
In the other 41 states and the District of Columbia, tax treatment of retirement benefits varies widely. For example, some states exempt all pension income or all Social Security income. Other states provide only partial exemption or credits and some tax all retirement income.
States exempting pension income entirely for qualified individuals are Illinois, Mississippi and Pennsylvania.
States that exempt or provide a credit for a portion of pension income include: Alabama, Arkansas, Colorado, Delaware, Georgia, Hawaii, Iowa, Kentucky, Louisiana, Maine, Maryland, Michigan, Missouri, Montana, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Virginia and Wisconsin.
States where pension income is taxed include: Arizona, California, Connecticut, District of Columbia, Idaho, Indiana, Kansas, Massachusetts, Minnesota, Nebraska, North Carolina, North Dakota, Vermont and West Virginia.
(See chart below for additional detail.)
Significant State Tax Reforms
States enacting changes to their income tax laws for retirement plans in 2017 include:
- Arkansas: Military retirement and survivor benefits are now exempt. However, a taxpayer claiming the exemption may not claim the $6,000 exemption on retirement benefits received from non-military sources. ( Change is effective beginning with 2018 tax year.)
- Connecticut: A complete deduction for retirement income will be phased-in from 2019 to 2025, the income thresholds for the Social Security deduction are increased beginning in 2019, and the increase in the teacher retirement system deduction (25% to 50%) is delayed until 2019. In addition, withholding is now required from pension or annuity distributions to Connecticut residents if the payer maintains an office or transacts business in the state. ( Change regarding withholding is effective beginning with 2018 tax year.)
- Indiana: A $6,250 deduction is available for military retirement and survivor's benefits. The $5,000 deduction for non-retirement military income, which was previously a combined deduction including military income and military retirement benefits, is retained. ( Change is effective beginning with 2018 tax year.)
- Kansas: Self-employed taxpayers may now claim the federal deduction for pension, profit-sharing, and annuity plans on their Kansas return. ( Change is effective beginning with 2017 tax year.)
- Maine: The deduction for certain dentists' military pensions is repealed. ( Change is effective retroactively beginning with 2016 tax year.)
- Maryland: Retired law enforcement, fire and rescue, or emergency services personnel who are at least 55 years old may exclude up to $15,000 of retirement income from taxable income. ( Change is effective beginning with 2017 tax year.)
- Michigan: The deduction for retirement benefits received for services in the U.S. armed forces is expanded to include pension benefits. In addition, an increased deduction for retirement or pension benefits from governmental employment is allowed for taxpayers born after 1945 who retired by 2013. ( Change is effective beginning with 2018 tax year.)
- Minnesota: A portion of Social Security benefits may be deducted. The maximum deduction is $4,500 for married couples filing joint returns, $3,500 for single and head of household filers, and $2,250 for married couples filing separate returns. ( Change is effective beginning with 2017 tax year.)
- New York: Distributions from a retirement plan may be deductible if used to pay for repairs to a primary residence in certain New York counties because of damage by above average precipitation and snow melt in April and May 2017. ( Change is effective beginning with 2017 tax year.)
- Utah: Small employers (10 to 19 employees) may claim a $500 tax credit for offering a qualified employee retirement plan. ( Change is effective for 2018 tax year only.)
- West Virginia: Military retirement income is exempt from tax. ( Change is effective beginning with 2018 tax year.)
- Wisconsin: Taxpayers over 70½ years of age may now make tax-free distributions from an IRA directly to a charitable organization. ( Change is effective beginning with 2018 tax year.)
While some states tax pension benefits, only 13 states impose tax on Social Security income: Colorado, Connecticut,
Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West
Virginia. These states either tax Social Security income to the same extent that the federal government does
or provide limited breaks for Social Security income, often for lower-income individuals.
(See chart below for full detail on State Taxation of Retirement Income.)
State Income, Property, Sales Taxes Can Add Up
In addition to state taxes on retirement benefits, other taxes to consider when evaluating financial factors on where to retire include:
State income tax rates:
For example, income tax rates also can have a significant financial impact on retirees in determining
where they want to live and can vary widely across the country.
While seven states have no income tax and two tax only interest and dividend income, several have a relatively low income tax rate across all income levels. For example, the highest marginal income tax rates in Arizona, New Mexico, North Dakota and Ohio are below 5 percent. Some states have a relatively low flat tax regardless of income, with the five lowest: Colorado (4.63 percent), Illinois (4.95 percent), Indiana (3.23 percent), Michigan (4.25 percent) and Pennsylvania (3.07 percent) for 2018.
- State and local sales taxes: Forty-five states and the District of Columbia impose a state sales and use tax (only Alaska, Delaware, Montana, New Hampshire and Oregon do not impose a state sales and use tax, although some Alaska localities do). States with a relatively high state sales tax rate of 7 percent include Indiana, Mississippi, Rhode Island, and Tennessee. California has a state sales tax rate of 7.25 percent. Local sales and use taxes, imposed by cities, counties and other special taxing jurisdictions, such as fire protection and library districts, also can add significantly to the rate. (View the Top 10 Highest & Lowest State Sales Taxes.)
- State and local property taxes: While property values had declined for several years after 2008 in many areas, it has not necessarily been the case for property taxes. However, many states and some local jurisdictions offer senior citizen homeowners some form of property tax exemption, credit, abatement, tax deferral, refund or other benefits. These tax breaks also are available to renters in some jurisdictions. The benefits typically have qualifying restrictions that include age and income of the beneficiary.
- State estate taxes: Estate taxes also can influence where seniors want to retire. Rules vary from state to state, as well as from federal estate tax laws. While some states, such as Hawaii and Maine, follow the federal exclusion amount, others do not. The latter category includes Illinois ($4 million), Massachusetts ($1 million), and New York ($5,250,000 for deaths on or after April 1, 2017, and before January 1, 2019; to increase to the federal exclusion amount in 2019).
Other states, including Arizona, Kansas and Oklahoma, no longer impose an estate tax. Still others, like California and Florida, technically still have such a tax on their books, but collect no revenue because their tax is based on the now-repealed federal credit for state death taxes. In general, this is an area of the law that has been in a considerable state of flux in recent years and will probably continue to be so in the foreseeable future.
State Taxation of Retirement Income
The following chart shows generally which states tax retirement income, including Social Security and pension income for the 2017 tax year unless otherwise noted.
SOURCE: Wolters Kluwer, 2018
Permission for use granted.