When living on a fixed income, the less you pay in taxes, the better. There are some states that are more tax-friendly than others. Three main types of state taxes – income tax, property tax, and sales tax – interact to determine the most tax-friendly states if you are retired or about to retire.
States That Do Not Impose Income Tax
Eight states do not impose income tax on earned income as of 2021: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. New Hampshire only taxes dividends and interest, so you can take a side job here without incurring tax costs. Tennessee also only taxed dividends and interest until 2020. It eliminated its tax on January 1, 2021.
Income Tax Exemptions for Retirees
Most states that impose an income tax also allow retirees to exempt some or all of their Social Security benefits and pension income from taxes. Thirteen states exempt pension income for qualifying retirees as of 2021: Alabama, Alaska, Florida, Illinois, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming.
States to Avoid
Some states are less friendly to retirees. Not only are some tax rates high, but they impose full taxes on pension income, in addition to 401(k) and IRA distributions. According to the Tax Foundation, a nonpartisan tax research group in Washington, D.C., these states and their highest tax rates as of 2021 are:
- California: 13.3% on income over $1 million ($1,198,024 for married couples)
- Minnesota: 9.85% on income over $166,040 ($276,200 for married couples)
- Vermont: 8.75% on income over $204,000 ($248,350 for married couples)
- Idaho: 6.925% on income over $11,760 ($23,520 for married couples)
- Connecticut: 6.99% on income over $500,000 ($1 million for married couples)
- Nebraska: 6.84% on income over $32,210 ($64,430 for married couples)
- West Virginia: 6.5% on income over $60,000 (for both single individuals and married couples)
- Rhode Island: 5.99% on income over $150,550 (for both single individuals and married couples)
- Kansas: 5.7% on income over $30,000 ($60,000 for married couples)
- North Carolina: 5.25% on all income, but Social Security benefits are not taxed
- Massachusetts: 5% on all income, but Social Security benefits included in federal income are not taxed
- Arizona: 8% on income over $250,000 ($500,000 for married couples), but Social Security benefits included in federal filing are not taxed
- Indiana: 3.23% on all income, but Social Security benefits are not taxed
- North Dakota: 2.9% on income over $440,600 (for single individuals and married couples)
Please note that California will impose an 8% tax starting in 2021 on income over $46,394. It is considered one of the highest rates in the country.
Property Tax Relief
Property taxes can be a burden for low-income retirees and those with high housing costs. However, all 50 states offer some form of property tax relief program.
Forty states offer exemptions for homes that reduce the assessed value of your home, or a tax credit that reduces your tax bill dollar for dollar. Most states also have specific exemptions for senior residents over a certain age. They may also need to meet income requirements.
According to Tax-Rates.org, residents living in Louisiana, Hawaii, Alabama, Delaware, the District of Columbia, and West Virginia pay the lowest property taxes relative to the value of their homes. Property tax in Nevada is based on only 35% of the fair market value of the property. Most states use 100% of the fair market value.
States
States with the Lowest Sales Taxes
There are only four states that do not impose a sales tax as of 2021: Delaware, Montana, New Hampshire, and Oregon. Alaska comes close. It does not impose a state sales tax but allows cities and counties to levy sales taxes at an average rate of 1.76%.
After Alaska, the four states with the lowest combined state and local sales tax rates as of 2021 are:
- Hawaii: 4.44%
- Wyoming: 5.33%
- Wisconsin: 5.43%
- Maine: 5.5%
The five states with the highest combined state and local sales tax rates as of 2021 are:
- Tennessee: 9.55%
- Louisiana: 9.52%
- Arkansas: 9.51%
- Washington: 9.23%
- Alabama: 9.22%
Conclusion
Income taxes may be a priority if you expect to have a high income or will continue to work part-time after retirement. Property and sales taxes may be of greater concern if you will be living on Social Security, as these benefits are exempt from taxes in many states.
Please note that the state providing the best overall tax climate for retirees depends on the type and amount of your income, the value of your home, and the cash you possess. This can influence any tax issues you may encounter.
However, there are some states that show distinct advantages. These include those with no income tax, those that exempt pensions and Social Security income, and states that also have low property and sales taxes.
These lists do not take into account climate, access to quality healthcare, and cost of living. Your financial perspective and what matters to you in the community you live in will determine your unique suitability for a retirement destination. Contact your accountant or financial advisor for more personal guidance on this matter.
Which States Do Not Tax 401(k) Withdrawals?
States that do not tax pension plans extend these same benefits to retirees with 401(k) plans. Your 401(k) withdrawals will not be taxed in Alaska, Florida, Illinois, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming.
How Much Can You Save in Retirement by Living in a Low-Tax State?
The more money you have to withdraw in retirement, the greater your opportunity to save on your tax bill. A person withdrawing $1.5 million annually can save 13.3% by moving from California to a state with no income tax, such as Wyoming. This means saving nearly $200,000 a year. However, most people will not withdraw more than a million dollars annually in retirement, so their tax brackets (and potential savings from moving to a low-tax state) are much lower.
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Sources:
- Tax Foundation. “State Individual Income Tax Rates and Brackets for 2021.”
- AARP. “14 States That Don’t Tax Pension Payouts.”
- Retirement Living. “Taxes by State.”
- AARP. “12 States That Won’t Tax Your Retirement Distributions.”
- Tax-Rates.org. “Property Taxes By State.”
- Tax Foundation. “State and Local Sales Tax Rates 2021.”
Source: https://www.thebalancemoney.com/best-states-for-retirees-3193239
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