For those approaching retirement, the decision of where to spend their golden years is crucial and multifaceted. While numerous elements influence this choice, one of the most pivotal considerations is the impact of state taxes on retirement income. Unlike federal income taxes, which apply universally, state-level tax policies vary significantly across the country and can materially affect retirees' net income.
Currently, 13 states in the United States stand out by not imposing state income taxes on retirement income. This exemption encompasses income derived from Social Security benefits, pensions, 401(k) plans, Individual Retirement Accounts (IRAs), and annuities, depending on the state. Understanding the nuances of these states' tax regimes can inform retirees' decisions and financial planning.
The Nine States Without Any Income Tax
Among the 50 states, nine have entirely eliminated state income tax on all income sources, including retirement earnings. These are Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. Their tax structures rely on alternative revenue streams rather than income taxation.
However, an important exception within this group is Washington State's unique treatment of capital gains. While Washington does not tax standard income and generally does not categorize capital gains as personal income, it imposes a capital gains tax of 7% on the first $1 million earned through capital gains, with an additional 2.9% tax on amounts exceeding $1 million. The other eight states in this cohort do not levy any taxes on capital gains. This detail is crucial for retirees with significant capital gains income considering relocation to or residing in Washington.
Four Additional States That Exempt Retirement Income
Beyond the nine states without any income tax, there are four additional states—Illinois, Iowa, Mississippi, and Pennsylvania—that specifically do not tax retirement income, although they maintain income taxes on other earnings. This means Social Security benefits as well as withdrawals from IRAs, 401(k)s, annuities, and pensions are exempt from state income tax in these states.
It is essential to highlight, however, that in Mississippi and Pennsylvania, early distributions from retirement accounts can be subject to state income taxes if taken before the age of 59 ½. This caveat affects retirees who might plan to access retirement funds ahead of the typical retirement age, indicating the importance of timing in retirement income tax planning.
Federal Tax Obligations and Temporary Relief Measures
While these 13 states offer relief at the state level, retirees should not overlooked their federal tax obligations. The United States federal government taxes retirement income regardless of state residency. For instance, Social Security benefits may still be partially taxable depending on overall income levels. Although recent federal legislation has introduced a temporary tax deduction for seniors, which will reduce federal tax liability on Social Security benefits, this measure is set to expire after 2028. Therefore, federal taxes remain an unavoidable consideration for retirees nationwide.
Additional Taxes and Cost of Living Considerations
Living in one of the states that exempt retirement income from state tax does not guarantee an overall lower tax burden or reduced cost of living. States must generate revenue from other sources, potentially offsetting the absence of income tax with other taxes and fees.
For example, Texas, although it charges no state income tax, ranks sixth in the United States for the highest property taxes. Tennessee imposes no income tax but has the nation’s second-highest sales tax rate. Washington also has a high sales tax, placing it fourth nationally. In Mississippi, while retirement income is untaxed, car tag fees are notably high, ranking second highest.
Moreover, the cost of living can vary sharply among these states. For instance, Alaska and Washington, both among the 13 states exempting retirement income from state income tax, are ranked sixth and seventh respectively for the highest cost of living in the country. This raises the importance of evaluating overall financial implications when selecting a retirement location, beyond just income tax advantages.
Conclusion
The choice of where to retire involves balancing many factors, with taxation on income and the cost of living being significant among them. Thirteen states offer environments where retirees can avoid state income tax on retirement benefits, while others balance their budgets with different revenue tools and variable living expenses. Consequently, retirees must thoroughly assess their individual financial situations and lifestyle preferences to identify the most suitable domicile for their retirement years.