Tax-Friendly Places for Retirement
Sunday, September 20, 2009
Maybe you're thinking about relocating in retirement, in hopes of enjoying milder weather and lower expenses. Before you make a move, it pays to assess the overall tax burden of your future home. Some states that are tax-friendly could get less chummy as they scramble to find new sources of revenue to plug gaping holes in recession-battered budgets.
No matter where you live, the federal taxes will be about the same. But you'd be amazed at how much your state and local tax burden may vary. And if you itemize deductions, how much you pay -- and deduct -- in local property taxes could affect the bottom line of your federal return, too.
People planning to retire "often use the presence or absence of a state income tax as a litmus test for a retirement destination," says Tom Wetzel, president of the Retirement Living Information Center. "But higher sales and property taxes can more than offset the lack of a state income tax."
Seven states -- Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming -- have no state income tax. Two states -- New Hampshire and Tennessee -- tax only dividend and interest income that exceeds certain limits. But many of the remaining 41 states (and the District of Columbia) that impose an income tax offer generous incentives for retirees. If you qualify, moving to one of these retiree-friendly areas could be cheaper than relocating to a state with no income tax.
Plus, in tough economic times, states without a personal income tax have fewer sources of revenue and are more likely to raise property or sales taxes and other fees to shore up their budgets. State tax revenue plunged nearly 12 percent during the first three months of 2009, the sharpest decline on record, reports the Nelson A. Rockefeller Institute of Government. And it may take states years to make up the shortfall.
Despite the dismal economy, there is one bright spot for retirees on the move: falling home prices. "We see exceptional opportunities in some sought-after retirement destinations," says Mary Lu Abbott, editor of Where to Retire magazine. If you thought locations such as Naples, Fla., Scottsdale, Ariz., and Hilton Head, S.C., were out of your price range, it could be a good time to take a second look. Property taxes, however, have not been moving down as quickly.
For a state-by-state tax guide, including special exemptions for seniors and a rundown on how various types of retirement income are taxed, see our interactive retiree tax map at http:/
Although most states that impose an income tax exempt at least a portion of pension income from taxation, they often treat public and private pensions differently. For instance, ten states -- Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania -- exclude all federal, military and in-state government pensions from taxation. But Kansas taxes public pensions from all other states. Pennsylvania and Mississippi, by contrast, exempt all retirement income -- including distributions from IRAs and 401(k) plans. Some states have special breaks based on age or income.
Three states are particularly tough on retirees. Not only do they fully tax most pensions and other retirement income, they also have high top tax brackets: California (9.55 percent on income less than $1 million), Rhode Island (9.9 percent) and Vermont (9.5 percent). Connecticut and Nebraska also fully tax retirement income.
Social Security Benefits
Depending on your income, you may be required to include up to 85 percent of your Social Security benefits in your taxable income when filing your federal return. But in recent years, many states have moved away from taxing Social Security benefits. In addition to the nine states that lack a broad-based individual income tax, 27 states and the District of Columbia do not tax Social Security: Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia 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 -- Alaska, Delaware, Montana, New Hampshire and Oregon -- have no state sales tax. At the other extreme, California's newly increased sales tax of 8.25 percent is the highest in the nation. Five other states -- Indiana, Mississippi, New Jersey, Rhode Island and Tennessee -- each have a state sales tax of 7 percent.
In 2008, more than 500 U.S. cities either increased their sales-tax rate or initiated a new sales tax.
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.
"America's Best Low-Tax Retirement Towns" is a good starting point if you're trying to determine the financial implications of moving. It rates the total tax burden for more than 200 cities, broken down by different income levels and home values and based on 2006 tax rates.
Based on data from a 2007 Census Bureau survey and Tax Foundation calculations, the five states with the lowest median real estate taxes (from lowest to highest) are Louisiana, Alabama, West Virginia, Mississippi and Arkansas. States with the highest median real estate taxes (from highest to lowest) are New Jersey, New Hampshire, Connecticut, New York and Rhode Island.