Retiring and Relocating? Don’t Neglect State Taxes!

October 9, 2014  | By Kevin Smith

If you’re retired, or about to retire, you may be thinking about relocating to a state that has low tax rates or provides special tax benefits to retirees. Here’s a survey that may jump-start your search for a tax-friendly state in which to spend your golden years.

State income taxes in general

State income taxes typically account for a large percentage of the total taxes you pay. So you may consider yourself lucky if you live in one of the seven no-income-tax states: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. (New Hampshire and Tennessee impose income tax only on interest and dividends.)

But if you’re considering a state that does impose an income tax, as a retiree you’ll want to know how that state treats Social Security and retirement income.

State income taxes and Social Security

Social Security income is completely exempt from tax in 28 of the states with an income tax (as well as the District of Columbia): Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia, and Wisconsin.

Some states (for example, Connecticut, Kansas, Missouri, and Montana) don’t tax Social Security benefits if income is less than a specified dollar amount (Nebraska joins this list in 2015). And at least three states (Colorado, Utah, and West Virginia) provide a general income exclusion or credit for seniors that takes Social Security into account. Most of the remaining states tax Social Security benefits to the same extent they’re taxed under federal law.

State income taxes and retirement income

Of the states with an income tax, most provide at least some relief for retirement income, but this can range from a credit of less than $500 (Ohio and Utah) to an exclusion for all or most retirement income (Hawaii, Illinois, and Mississippi). Only a handful of states, including California, Nebraska, North Carolina, North Dakota, Rhode Island, and Vermont, currently tax all retirement income and don’t provide any general income exclusion for seniors.

Make sure you understand how your particular type of retirement income is treated. Some states exempt public pensions, but tax private pensions; or exempt public pensions earned in that state, but not public pensions earned in another state. Some states exempt employer retirement benefits, but not IRA income. Others exempt a specific dollar amount of retirement income, but only if you’ve reached a certain age or have income within certain limits. In some states, military pensions are partially or fully exempt, while in others they’re fully taxable. Some states exempt defined benefit pension payments, but tax 401(k) distributions. A good source for information is your state’s Department of Revenue website.

Can the state I’m moving from tax my benefits?

What happens if you spent your working life in a state like California that fully taxes retirement income, but you relocate after you retire to Florida, a state that has no income tax? Can California tax your pension benefit? While the answer used to be unclear, federal law now clearly prohibits states from taxing certain retirement income unless you’re a resident of, or domiciled in, that state.

Whether you’re considered a resident of, or domiciled in, a state is determined by the laws of that particular state. In general, your residence is the place you actually live. Your domicile is your permanent legal residence–even if you don’t currently live there, you have an intent to return and remain there. So in our example, if you’re no longer a resident of, or domiciled in, California, that state cannot tax your pension benefit under federal law.

The law applies to all qualified plans (for example, 401(k), profit-sharing, and defined benefit plans), IRAs, 403(b) plans, 457(b) plans, and governmental plans.

The law provides only limited protection for other (nonqualified) deferred compensation plan benefits. So-called “top-hat” plan benefits that are paid over an employee’s lifetime, or over a period of at least 10 years, are covered by the law. But stock options, stock appreciation rights (SARs), and restricted stock are not; states are free to tax these benefits even after you relocate.

Other considerations

Remember that states impose many other kinds of taxes (for example, sales, real estate, and gift and estate taxes). Some states offer special tax breaks to seniors, like property tax reductions or additional exemptions, standard deductions, or credits based on age. For an accurate comparison among the states, you’ll need to consider your total tax burden. A tax professional can assist you in this task.

For an accurate comparison among the states, you’ll need to consider your total tax burden. A tax professional can assist you in this task.

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Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2014.