As people drift closer to retirement, one of the more exciting things to start planning for is “if and where” they are going to relocate after they finish working. Whether it is the sun calling their name, a new pace of life, or grandkids, there is a lot to consider. Some of the most common things people will look at are housing cost, medical access, energy cost and transportation options. As financial planners, we like to remind clients to consider the tax implications in the state where they are looking to relocate. While it might seem like common sense to simply avoid the states with the highest marginal rate (think California, New York, and New Jersey), that might not be the most effective way to rate your retirement locations.
Taxes can be analyzed from a variety of perspectives: income tax, property tax, estate or inheritance tax, sales tax, and more. Today we are going to dive into the world of state income tax. There are four types of state tax breaks that retirees should consider: no income tax at all, exclusion of social security income, exclusion of pension or retirement plan withdrawals, and deductions or credits for all taxpayers above a certain age. Every single state within the US has at least one of these exclusions wrapped within their state income tax rules.
While income brackets often determine whether you will pay state income tax, there is a collection of states where, regardless of your income, you will pay no state tax. These states include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. While obviously this is the biggest “break” you can have, there are other breaks out there.
Social security is one of the common sources of retiree income. As we know, at a federal level, depending on your income, up to 85% of your social security benefits are considered taxable income. The great news is there are 31 states that exclude social security income from their taxable income. If we include the 8 states with no state income tax, that leaves only 11 states that fully or partially tax social security. Those states include Colorado, Montana, Utah, New Mexico, Nebraska, Kansas, Minnesota, Missouri, Vermont, Connecticut, and Rhode Island. It is worth pointing out that some of the states that have the highest marginal rate (think California) don’t tax social security income which may be one of retirees’ main sources of income, reminding us that looking at marginal rates alone can be misleading.
Income from Pensions and Retirement Plans is another main source of income for retirees. While the majority of these benefits are included as taxable income federally, unless you are drawing from a Roth IRA, there is a collection of states that will fully or partially exclude this income from their state tax. Mississippi, Illinois, and Pennsylvania fully exclude all pension and qualified retirement draws upon reaching age 59.5. An additional 21 states offer a variety of exclusions of pension and retirement plan income based on age, income levels, and social security income.
While not a perfect science, something else to consider is age-based exemptions, deductions, and credits. Instead of applying to one specific type of income (like social security, pension, or qualified retirement plans) these retirement friendly age-based benefits can be applied against all types of income. This may come in the form of a higher standard deduction for retirement age, various credits, or set deductions.
In summary, what one person may consider tax friendly for their type of income is different than the next. Analyzing highest marginal rates alone doesn’t tell the full story and considering state tax rates alone also doesn’t tell the full story. After a lifetime of working, retirement planning is made up of qualitative and quantitative decision making. As you start narrowing down your dream retirement locations, work with your financial advisor to run your top picks through your financial plan. We will help you with the quantitative analysis so you can focus on your quality of life.
Sadie Bjornsen Maubet
Associate Financial Advisor
2/13/23
Commentary: The opinions expressed are those of Alaska Wealth Advisors Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.
Note: This material should not be construed as tax advice. You should always consult with your tax professional with regard to specific tax questions and obligations.
