Finding a tax-friendly state for retirement
For those fortunate enough to be able to select a location in which to live after they retire, there are a number of factors to consider: warmer weather, nearness to friends and family -- and taxes. Not only do taxes partially determine the best places to stretch a fixed retirement income, they impact the size of the estate that retirees will be able to pass to their heirs.
The taxability of retirement benefits varies widely from state to state, according to Rocky Mengle, senior state tax analyst at Wolters Kluwer Tax & Accounting.
Currently, seven states do not tax individual income, retirement or otherwise, he indicated: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Two other states – New Hampshire and Tennessee -- impose income taxes only on dividends and interest, at a 5 percent flat rate for both states. 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, while other states provide only partial exemption or credits, and some states tax all retirement income.
“The general trend of the last several years across all states is to be more taxpayer friendly when it comes to retirees, particularly with regard to military and government retirement income,” Mengle observed. “Military pensions may be exempted completely, or if they already have a partial exemption in place, the state might sweeten it a bit and make it a little better for the retiree,” said Mengle.
For example, military retirement pay is now deductible in Minnesota, beginning with the 2016 tax year. A new deduction for military retirement income is allowed in South Carolina, to be phased in over several years.
While some states tax pension benefits, only 13 states impose tax on Social Security income. “Most states exempt Social Security,” he said. “There are some states that might have an age or income restriction of some sort, but the majority of states have a complete exemption from Social Security. It’s a little more mixed when you consider other types of retirement income, such as pension income and 401(k)s. The majority of states have a complete or partial exemption, but they are more likely to give a partial exemption based on income levels, or reaching a certain age.”
For retirees shopping around for states to move to in their retirement years, the type of income a retiree expects is a key consideration, according to Mengle: “For example, if the bulk of a retiree’s income will be Social Security benefits, then North Carolina would be very tax-friendly. On the other hand, if the bulk is from a private pension plan, North Carolina would not be so friendly because an individual taxpayer’s pension income is generally taxable there.”
”Most states with income tax do impose tax on rental income, but two states – New Hampshire and Tennessee – do not,” said Mengle. “They tax only dividends and interest, so a retiree with rental income might be better off in those states than retirees that are heavily invested in the stock market.”
Of course, state income taxes on retirement benefits are not the only taxes to consider, Mengle said. “Sales taxes at the state and local levels and property taxes can make a difference in a retiree’s overall tax liability,” he observed.
In fact, the Census Bureau has just announced that property taxes paid by Americans for fiscal year 2016 rose by 3.2 percent from the 2015 fiscal year, to an all-time high of $540,701,000,000.
And for retirees with significant wealth to pass to their heirs, state estate taxes must be considered. While some states, such as Delaware and Hawaii, follow the federal exclusion amount ($5,450,000 in 2016 and $5,490,000 in 2017), others do not, according to a Wolters Kluwer review.
Some states, such as Arizona, Kansas and Oklahoma, no longer impose an estate tax, while others, including California and Florida, technically still have such a tax on their books. However, they collect no revenue since their tax is based on the now-repealed federal credit for state death taxes.