If you are thinking about places to live when you retire, you also have to think about income taxes. You don’t have much control over your federal income tax burden but you can control your state tax burden by choosing your retirement state wisely. Finding a state with low taxes for retirees is not as straightforward as it may seem. Let’s take a look.
States with No Income Taxes on Retirement Income
Two other states—New Hampshire and Tennessee—tax dividend and interest income that exceeds certain income limits. This tax would be relevant for retirees who use quite a bit of dividend or interest income to live on.
Of course, you can never be certain that the tax environment won’t change in any of these states. Alaska is probably tax-safe because of its substantial oil revenues. Other states with no income tax may require constitutional amendments to impose a new tax. That’s hard to do in today’s political climate. It would be particularly hard to create a new state income tax and apply it to retirees because of their voting power.
States with Special Retirement Tax Benefits
Pension income is often taxed differently in many states. Most states that have an income tax exempt at least some pension income from taxation. However, these same states may tax public and private pensions differently.
As examples, Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania exclude all federal, military and in-state government pensions from taxation. Yet Kansas taxes public pensions from all other states. That’s important information to know.
Pennsylvania and Mississippi exempt all retirement income (including distributions from IRAs and 401(k) plans) from state income taxes. That’s a fabulous benefit to retirees.
Other states offer special tax breaks based on age or income. As one example, New Jersey allows its residents who are 62 and older and who have incomes less than $100k to exclude up to $20,000 of private pension income from taxes.
New York state allows residents who are 59½ and older to exclude up to $20,000 of private or out-of-state public pensions from taxes. This exclusion applies regardless of their total retirement income.
Michigan residents can exclude up to $43,440 of private pension income from state taxes in 2009. This exclusion doubles for married couples.
High Tax Retirement States to Avoid
According to my research, there are at least three states you should avoid as a retirement destination if high income taxes are a concern.
The worst states tax 100% of most pension and other retirement income. Making things worse is that their marginal tax brackets are at the high end of the scale. These states are California (9.55% tax rate on income less than $1 million), Rhode Island (9.9% tax rate) and Vermont (9.5% tax rate).
Connecticut and Nebraska also tax all retirement income, with top tax brackets of 5% and 6.84%, respectively. Not great either. I wouldn’t be moving to any of these states to retire.
In addition to income tax burdens, many retirees also have to be concerned with property taxes. For more information about those burdens, read my post on retirement tax burdens.
If you want to see a map showing relative tax burdens on retirees, Kiplinger’s has one for you.