When it comes to finding a state to which to retire, there are plenty of factors to consider. There’s the weather, proximity to family and friends, access to health care, quality of life, and the list goes on.
But one factor that you might want to weigh more heavily than others when deciding where to live in retirement is the degree to which your precious income and assets will be taxed.
Do Your Tax Homework
“Retirees should really do their homework on the types of taxes they’d be responsible for paying and the rates they’d be taxed at when comparing different locations,” Sandy Weiner, a state tax analyst for Wolters Kluwer, CCH, said in a release.
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Specifically, you should consider, according to Weiner and others, state taxes on retirement benefits, state income-tax rates, state and local sales tax rates, state and local property taxes, state estate taxes, state inheritance taxes and the overall tax burden.
Indeed, the best state for you to retire to, tax-wise at least, will depend on many personal factors including your level of income, your sources of income, how you spend your money, whether you are able to itemize deductions and how states and municipalities raise revenue. (Some states, for instance, might seem like a haven for retirees by one measure, but not by another.)
So, let’s say that you are among those retirees in the upper income quartile, who have, on average, income of $78,180 and where 18 percent of your income or $14,072 comes from Social Security, 22 percent or $17,199 comes from a pension, 44 percent or $34,399 comes from earnings, and the rest comes from your various retirement accounts in the form of dividends, interest income, and capital gains. If you plan to continue working, you ought to move to a state that has no income tax.
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If You Plan to Work in Retirement
According to Weiner, seven states fall into that category: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. And two other states, New Hampshire and Tennessee, impose taxes only on dividends and interest (5 percent for New Hampshire and 6 percent for Tennessee).
You might also consider states that have a relatively low income-tax rate across all income levels.
For example, the highest marginal income-tax rates in Arizona, Kansas, New Mexico and North Dakota are below 5 percent, according to Weiner. And some states have a relatively low flat tax regardless of income, with the three lowest being Indiana (3.4 percent), Michigan (4.25 percent) and Pennsylvania (3.07 percent). And, according to Weiner, the Illinois flat tax rate will be reduced from 5 percent to 3.75 percent in 2015.
(MORE: 7 Key Changes to the 1040 Tax Form)
If You Rely Mostly on Social Security and Pensions
But what if you’re more an average retiree household, where 36.7 percent of your income comes from Social Security, 30.2 percent from earnings, 18.6 percent from a pension, and the balance from your accounts earmarked for retirement?
In this case, you might consider moving to one of the 10 states that doesn’t tax your Social Security and private pension income. They are Alaska, Florida, Mississippi, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming, according to Weiner.
For the record, Weiner said, many states may tax all your pension income, but if you’ve worked for the state government, they may exempt it. In other words, you might not want to move out of state if you were a state worker.
Big Spenders Might Consider These States
Now if you’re the sort of retiree who plans to spend a lot of money buying things in retirement, consider living in one of the five states that don’t impose a state sales-and-use tax: Alaska, Delaware, Montana, New Hampshire and Oregon.
For the record, 45 states and the District of Columbia impose a state sales-and-use tax, according to CCH, and some much more than others. So, big spenders might want to avoid moving to California, which has a state sales tax rate of 7.5 percent, and Indiana, Mississippi, New Jersey, Rhode Island and Tennessee, all of which have a state sales tax rate of 7 percent.
It’s also wise to check other types of taxes might affect you. According to CCH, local sales and use taxes, imposed by cities, counties and other special taxing jurisdictions such as fire protection and library districts, also can add significantly to your rate.
The Most Tax-Friendly State
When all is said, it would seem — by almost every measure — that Wyoming
is the most tax-friendly state in the country for retirees. “It’s a low populace state and they’ve taken a very conservative approach to taxes,” said Weiner, who noted all the no-income-tax states ought to be viewed as the most tax-friendly.
All things being equal, the other top tax-friendly states are Alaska, Florida, Mississippi, New Hampshire, Nevada, South Dakota, Tennessee, Texas, and Washington. “Alaska and Nevada have revenue sources from natural resources and from gambling,” said Weiner. Check this chart
to see how your state taxes various tyes of retirement income.
The Least Tax-Friendly States
For the record, the least income tax-friendly states, if the bulk of your retirement income is coming from pensions and Social Security, are Nebraska, North Dakota, Rhode Island, Vermont and West Virginia.
Regardless of your sources of income, you probably don’t want to move to a state that taxes all of your retirement income. According to Weiner, states generally taxing pension income include: Arizona, California, Connecticut, District of Columbia, Idaho, Indiana, Kansas, Massachusetts, Minnesota, Nebraska, North Dakota, Rhode Island, Vermont, West Virginia, and North Carolina beginning with the 2014 tax year.
And 14 states impose a tax on Social Security income: Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, New Jersey, North Dakota, Rhode Island, Vermont and West Virginia. According to CCH, those states either tax Social Security income to the same extent that the federal government does or provide breaks for Social Security income, often for lower-income individuals.
In addition, consider the degree to which a state taxes capital gains. If you’re a business owner, for instance, review with a tax accountant how different states might tax the sale of your business. “They may not want to get that income when they are living in California,” said Weiner. “They may want to move first and then sell the business.”
Watch Out for High Property Taxes
States that tend not to tax retirement income have to generate revenue somehow. And more often than not, that revenue comes in the form of other taxes such as property and sales. New Hampshire, for example, has no personal income tax but property taxes in the live-free-or-die state, as a percent of property values, are the third highest in the country.
So while, you might fancy moving to a place that doesn’t tax your retirement income, do consider what you might pay — gross and net after taxes — in property taxes.
According to a 2008 Tax Foundation
report there are at least 16 states where residents pay in property taxes 1.2 percent or greater of their home’s value. Those include Texas, New Jersey, Nebraska, Wisconsin, New Hampshire, Illinois, Vermont, Connecticut, Michigan, North Dakota, Pennsylvania, Ohio, Kansas, South Dakota, Iowa, and Rhode Island. Check this list
posted by Yahoo! Finance for the 10 states with the lowest real estate taxes.
Of course, like politics, all property taxes are local. So, before you include or exclude this or that state, check out the property taxes in the municipality you have designs on moving to and check whether there might be any exemptions for retirees.
In some states, the property taxes might appear to be high but there may be circuit breaker exemptions, Weiner said. Indeed, many states and some local jurisdictions offer senior citizen homeowners some form of property tax exemption, credit, abatement, tax deferral, refund or other benefits, CCH said. These tax breaks also are available to renters in some jurisdictions. And, as you might predict, CCH said the benefits typically have qualifying restrictions that include age and income of the beneficiary.
Consider Overall Cost of Living
For some, it might make sense to move to a low-income tax, high-property-tax state, although Weiner cautioned that all costs, not just taxes, should be considered before moving to this or that tax-friendly state.
“I have friends who moved to Nevada but now say they are paying $300 a month for air conditioning,” she said. “It can have a very strong impact if you haven’t thought through all the consequences.”
Of course, when it comes to deciding which state to retire to, you ought to get a sense of the overall tax burden you'll face. For instance, Connecticut has the highest per capita state and local tax burden in the nation at $6,984, while Mississippi has the lowest at $2,625. Check the Tax Foundation's state-by-state tax comparison booklet to see how your state fares.
Reforms Changing the Landscape
And don’t forget that nothing is ever certain when it comes to taxes. Right now, plenty of states, including Kentucky, Maine, Michigan, North Carolina and Oregon, are changing the way they tax retirement income — sometimes for the better and sometimes not.
Consider: In Oregon, the pension-income credit against benefits was extended for an additional six years while in North Carolina, the $2,000 deduction for income from private retirement plans is repealed beginning with the 2014 tax year.
So before you load up the truck and head to another part of the country, check what state lawmakers are planning with respect to taxes and retirees.
Don’t Forget Estate and Inheritance Taxes
And last but not least, don’t forget about estate and inheritance taxes. Yes, the super- and even the not-so wealthy should examine these taxes, too, before deciding where to retire.
You’ll have to do some legwork when it comes to estate and inheritance taxes, since the rules vary from state to state as well as from federal estate tax laws, according to CCH.
But the good news is this: Most states do not collect estate and/or inheritance taxes, according to James Walschlager, an estate planning analyst for Wolters Kluwer, CCH. “The American Taxpayer Relief Act brings more clarity on the federal level that only estates above the $5 million mark indexed for inflation will be subject to the federal estate tax,” Walschlager said in a release.
Still, the threshold in some states can be below $1 million for state estate taxes, which can impose additional planning challenges, Walschlager noted.
According to Walschlager, those states with an estate tax are Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Vermont and Washington, as well as the District of Columbia.
In addition to estate taxes, seven states also collect an inheritance tax, according to Walschlager. They are Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee, which will be phasing out its inheritance tax in 2015.
The inheritance tax is a tax on the portion of an estate received by an individual. It is different from an estate tax, which taxes an entire estate before it is distributed to individual parties. Assets transferred to a spouse are exempt from the inheritance tax, and some states exempt assets transferred to children and close relatives.
So, what are the least tax-friendly states from an estate and/or inheritance tax perspective? Well, that list would include Connecticut, the District of Columbia, Maryland, Massachusetts, Minnesota, New Jersey, New York, Ohio, Oregon and Rhode Island, with New Jersey and Rhode Island being the worst. Walschlager said New Jersey tops the least estate-tax friendly list with a $675,000 filing threshold and Rhode Island follows with a $921,655 threshold. But he also noted that Pennsylvania’s inheritance tax generally applies to every beneficiary, except for the surviving spouse, at rates ranging from 4.5 percent to 15 percent.
Dry Tax Runs
One helpful exercise that you might consider before moving to this or that state: Ask your CPA or some other qualified professional to conduct what-if scenarios with your tax return. Using your actual income and expenses, determine what you would pay in state and local taxes if you moved. Only then will you know if you’re in most tax-friendly state for your money.
“If you’ve got high income look at it at that level,” said Weiner. “Because it can have significant consequences.”
Robert Powell is a MarketWatch retirement columnist. He has been a journalist covering personal finance issues for more than 20 years. Follow him on Twitter @RJPIII.
This article is reprinted with permission from MarketWatch.com. © 2015 Dow, Jones & Co., Inc. All Rights Reserved.