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The Most and Least Tax-Friendly States for Retirees

Seven are best if you plan to work in retirement

By Robert Powell and MarketWatch

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.

“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.

(MORE: Planning to Retire? Start With the Right Question)

 

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.

(MORE: Best Places in the World to Retire)

 

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.

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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

 

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.

Robert Powell writes about retirement issues for MarketWatch.com and produces the Retirement Weekly subscription newsletter. Read More
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