Most retirement savers tend to focus on how much money they’re putting away for retirement and how much their investments are earning. These are certainly important factors when it comes to planning for a financially comfortable retirement.
But there’s another critical, often overlooked, factor that’s just as important: taxes. Different states tax retirement, pension and Social Security income differently. There are also big differences in how states assess sales and use taxes and how localities assess sales and property taxes, especially on residential real estate.
These differences in taxation could have a big impact on your retirement finances, especially when it comes to how long your retirement nest egg lasts. So it’s a good idea to do some research into state taxation before deciding where you’ll spend your golden years.
State Taxation of Individual Income
There are currently seven states in which individual income is not subject to tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. In two other states — New Hampshire and Tennessee — only dividends and interest are subject to state taxes.
The tax treatment of retirement income varies considerably in all the other states. For example, 401(k), IRA and pension income is exempt from state tax in Illinois, Mississippi and Pennsylvania. In Alabama and Hawaii, pension income is exempt from state tax but income from 401(k)s and IRAs isn’t.
A number of states exempt or provide a credit for a portion of pension income — they 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
Wisconsin
The state income tax rate is another important consideration. In Arizona, New Mexico, North Dakota and Ohio, for example, marginal income tax rates are below 5 percent. Colorado, Illinois, Indiana, Michigan and Pennsylvania, meanwhile, each have flat tax rates below 5 percent. Conversely, the highest state income tax rates are in California (13.3%), Hawaii (11%), Oregon (9.9%), Minnesota (9.85%), Iowa (8.98%), New Jersey (8.97%), Vermont (8.95%) the District of Columbia (8.95%), New York (8.82%) and Wisconsin (7.65%).
State Taxation of Pension and Social Security Income
Meanwhile, 13 states and the District of Columbia fully tax pension income:
Arizona
California
Connecticut
Idaho
Indiana
Kansas
Massachusetts
Minnesota
Nebraska
North Carolina
North Dakota
Vermont
West Virginia
And 13 states also tax Social Security income:
Colorado
Connecticut
Kansas
Minnesota
Missouri
Montana
Nebraska
New Mexico
North Dakota
Rhode Island
Utah
Vermont
West Virginia
Some of these states that tax Social Security income provide tax breaks for low-income couples and individuals. Also, West Virginia will start phasing out state taxation of Social Security benefits starting in 2021.
State, Local Sales and Use Taxes
State income taxes aren’t the only taxes that can affect your income in retirement. State sales and local sales and use taxes can also take a bite out of your retirement finances. All states and the District of Columbia impose these taxes except Alaska, Delaware, Montana, New Hampshire and Oregon.
The highest state sales taxes are in California (7.25%), Indiana, Mississippi, Rhode Island and Tennessee (7.0% in each). On the flip side, the lowest state sales taxes are in Colorado (2.9%), Alabama, Georgia, Hawaii, Louisiana, New York, South Dakota and Wyoming (3.0% in each). Local sales and use taxes, meanwhile, are assessed by cities, counties and special taxing jurisdictions. These vary widely all across the country.
State and Local Property Taxes
State and local property taxes are another important factor to consider. The biggest property tax paid by most retirees is the annual tax paid on the value of their home. However, some states and local jurisdictions offer property tax exemptions, credits and abatements to retirees, such as an exemption from paying the school tax portion of their property taxes.
Next Steps for You
Retirement tax planning can be complicated and the details vary from one individual or couple to the next. So be sure to talk to your tax advisor and personal financial planner for guidance in your specific situation.
Managing your tax situation is a year-round — and life-long — endeavor. You can take a few actions now to get yourself on the right track.
Download 5 Tax Hacks for Investors, an actionable guide with insights from fiduciary financial advisors. The guide is free.
Sign up for the Personal Capital Dashboard. Millions of people use these free and secure professional-grade online financial tools. You can use them to see all of your accounts in one place, analyze your spending, and plan for long-term financial goals.
Consider talking to a fiduciary financial advisor for more detailed guidance on your tax optimization strategies.
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Personal Capital compensates Don Sadler (“Author”) for providing the content contained in this blog post. Compensation not to exceed $500. Author is not a client of Personal Capital Advisors Corporation. The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
