A warm climate? National parks? Remaining close to your family? Proximity to a bigger city? Maybe getting away from the hustle and bustle? These are all very important factors in deciding where to retire. However, there are also financial considerations. In this article, we will review the best/worst states to retire from a tax perspective. Next month, we will review the most/least estate planning friendly states.
Income Taxes (Income/Retirement Plans)
There are seven states that do not impose an income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming (with an eighth, Tennessee, soon to be added). Thus, retirement plans are not taxed in these states. New Hampshire and Tennessee only tax dividend and interest income (and Tennessee is slowing phasing out the tax on such income with full phase-out in 2022). While states that lack an income tax may seem like the most attractive option, they may have steep property or sales taxes, which could easily offset the lack of income tax.
Federal laws dictate that state tax policy cannot discriminate against federal civil service pensions. This means that they cannot have more favorable tax treatment for state and local pensions than they do for federal civil service pensions. They can however create tax policies that discriminate between their own state pensions and other state’s pensions.
Arizona, Idaho, Kansas, Louisiana, New York, Oklahoma, and the District of Columbia provide greater tax relief plans for their state’s pension plans than they do for out-of-state government pension plans.
Only ten states excludeallfederal, state, and local pension income from taxation. These include Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania (note that Michigan only excludes such income for those born before 1946).
State income tax exclusions for private pension income are not as generous as those for Social Security and public pensions. In fact, twelve states and the District of Columbia fully tax private pensions. Those states are: Arizona, California, Idaho, Indiana, Kansas, Massachusetts, Minnesota, Nebraska, North Dakota, Rhode Island, Vermont, and West Virginia.
On the other hand, Alabama, Illinois and Hawaii exempt nearly all retirement income. They exempt 100% of Social Security, military pensions, government pensions, and certain types of private pensions. Only Mississippi and Pennsylvania exempt all retirement income, including 401(k) and IRA distributions.
Property taxes are a major cost factor, particularly for retirees living on fixed incomes. But many local jurisdictions offer property-tax breaks to full-time residents, some based on age alone and others linked to income. Tax rates vary significantly from state to state and among cities in the same state. For example, a retired couple with an annual income of $90,000 and a home worth $525,000 would pay about
$11,800 in total state taxes if they lived in the upscale community of Boca Raton on the east coast of Florida; but if they lived in the ritzy enclave of Naples on the state’s Gulf Coast, they’d pay about $4,000 less, according to America’s Best Low-Tax Retirement Towns (Vacation Publications).
Based on data from a 2015 Census Bureau survey, the five states with the lowest real estate effective tax rate (which is calculated by taking the real estate tax on the median home value in the state divided by the median home value in the particular state) are in order Hawaii, Alabama, Louisiana, Delaware and Washington D.C. On the other end of the spectrum, the states with the highest effective tax rate in order are New Jersey, Illinois, New Hampshire, Connecticut and Wisconsin.
Don’t forget to include state and local sales taxes in your personal budget analysis. Some states exempt food and medicine; others tax every dime you spend. Five states— Delaware (none), Montana (none), Oregon (none), New Hampshire (none) and Alaska (1.76%)—have the lowest state/local sales taxes. At the other extreme, Louisiana has the highest state sales tax at 9.98%, followed by Tennessee (9.46%), Arkansas (9.3%), Alabama (9.01%) and Washington state (8.92%).
Decision is situational.
In doing research for this article, we ran across many really great resources. We steered away from naming the “top 10” states to retire or something of the sort, because in the end, this decision is very fact specific. It is best to evaluate your retirement decision based on your needs and desires, and the financial aspect is just one thing to consider.
I feel that the site below does a tremendous job of explaining the tax benefits/costs of each individual state:
If you would like to discuss your situation further, please feel free to reach out to us; we are here to help you in making this important life decision.
Karen DeRose and Anthony DeRose are registered representatives of Lincoln Financial Advisors.
Securities and advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. DeRose Financial Planning Group is not an affiliate of Lincoln Financial Advisors.