September 21, 2015 — We thought this topic would be easy. Do some basic research, then come up with a list of the worst states for taxes on retirement. But after looking at the research we had to say – not so fast! There are so many considerations depending on your individual circumstances that any cut and dried, one size fits all approach is not going to be useful. All of these factors, for example, will have a major effect on your tax bill from one state to another: your income, the value of your home, the type of retirement income you get (and where it comes from), and whether you file singly or jointly. Yet we will try to come up with such a list, thinking of a prototypical couple that might, or might not, be similar to your situation. In this case we are focusing on worst states for retirement income taxes, and ignoring other taxes like those on property.
Back in 2011 we ran a similar exercise. In that one we had a hypothetical retirement couple (both over 65) who derives their income from a roughly equal combination of social security, (non-government) pension, and investment income. At that time we arbitrarily computed income taxes for 2 income levels: $60,000 and $100,000. We then applied all the standard, personal, and over 65 exemptions we could find. These income levels are obviously higher than what typical retirees earn; however our feeling was that below $60,000, income taxes are not that significant, and other considerations (mainly property tax) become much more important (see end of article for the 10 least friendly retirement tax states we listed back in 2011.
This year we are going to take a different tack. We will once again use a hypothetical couple, but this time with an arbitrary income level of $50,000 – an amount that about 40% of the respondents to our recent retirement income survey say they will exceed or be close to.
Not so simple
You would think that you could just look at the 10 states with the highest income taxes and say those were the ten least friendly states for retirement income taxes. But it is not that simple. Some of the considerations you need to take into account are:
– What are the marginal rates that come into account, and at what levels. Some states like California have high marginal rates (e,g.; 13.3%), but those rates wouldn’t come into play for our couple’s $50,000 income. Eight states, such as Pennsylvania, have a flat tax (3.07%) – everybody pays the same rate.
– Single taxpayer vs. filing jointly. Some states like NY double the exemption levels for couples, others like MN increase them, and some like South Carolina don’t change them at all. This can have a significant effect on our hypothetical couple.
– Exemptions and credits. This is perhaps the trickiest area to consider. Some states have very high standard exemptions, for example Connecticut, which offers a $14,000 credit per individual. In states like that, unless you exceed a fairly high threshold, the income tax is close to irrelevant. There are also exemptions based on age and disabilities to consider. A few states like Oregon allow you to deduct federal taxes from your state income; most states do not. Yet another complication – New York has something called tax benefit recapture – theirs is a different kind of marginal income rate; when many high income taxpayers reach a new bracket they pay that higher rate on all their income.
– Source of income. Tennessee and New Hampshire tax only dividends and interest. Some states exempt military or all government pensions, others exempt in-state government pensions, but not ones from outside the state. Most states exempt social security income. These states tax SS totally or in part: Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Vermont, West Virginia, and Utah. If most of your income is from Social Security then these states might not be so attractive, and the states that don’t tax it on our list below might not be so bad.
– Income taxes are only part of the picture. In this article we are focusing on income taxes. But as we have mentioned in many other articles, property taxes are often the biggest burden for retirees, along with estate taxes, and sales taxes can have some bearing.
The Tax Foundation has an excellent page explaining many of the above issues (note: the chart on that page is for filing singly, the example below is for a couple filing jointly).
10 states with the highest taxes on retirement income
Think of this not as a definitive list, but rather as a starting point if state income taxes are important to you. Your situation might be different enough that this list doesn’t apply to you. In our example we use a hypothetical couple with an income of $50,000. It does not take into account any other deductions or credits that might apply in your situation, such as a state, federal, social security, or military pension that might be exempted in all or in part in some of these states. The marginal rate shown is the one that applies if you go over the $ figure in the 3rd column. If your income is a lot higher than $50,000 the marginal rate might go even higher in many states, and the tax implications worse. The 4th column shows generally applicable exemptions and credits for each state. We have not attempted to rank these states, they are presented in alphabetical order.
Note that we are not accountants or tax professionals, we have merely reviewed what we believe are reliable resources to come up with information that you can use as a start for your research. Do not make an important tax decision without careful consideration and professional help. Our source for most of this information is Tax-Rates.org.
Of the 10 states above, Hawaii, New York, and South Carolina are the tax friendliest to retirees whose income is mostly pensions and SS. The other 5 states which do not tax SS look better to folks who will have significant SS income. Minnesota and Montana, both of which tax Social Security, might be the least tax friendly states on this list. Georgia was originally on this list, but we removed it after we realized that its over age 62 and 65 exemptions are so high ($35,000 and $65,000 each) that our prototypical couple would probably pay no income tax in that state. This list would definitely change if your joint income is a lot higher than $50,000 – e.g.; California would definitely come into play.
The chart above does not provide complete detail on the tax situation for retirees in those states. For example, some provide partial exemptions on pensions of certain types, while others exempt all. Some exempt pensions but tax earned income. For more detail on all 50 states see our State Retirement Guides.
Income taxes are just one consideration when it comes to choosing a low-tax retirement state. In many cases property taxes might be a much more important thing to consider. For people whose income is mostly Social Security, most of the states listed above might not as high tax as it first seems. Before you let a list like this make you jump to some conclusions, it would be wise to model what your income taxes would be after you applied all exemptions and credits. And of course you should remember the words of a lawyer we admire, who cautions that you shouldn’t let the tax tail wag the dog (translation: do what makes you happy first).
Since taxes on income are only part of the retirement tax situation, we will develop a future article on the worst states for property and estate/inheritance taxes – the other key kinds of taxes that retirees face.
Worst states from our 2011 article
Please remember that the 2011 article used different criteria to develop this list, and state tax laws change all the time.
6. West Virginia
7. Rhode Island
For further reading:
For a different take on this see this MarketWatch article: “Most Tax Friendly States for Retirement”
Most Tax Friendly States for Retirement
5 Thoughts on why taxes are the worst reason to pick a place to retire
Most important retirement financial tax issue is not what you think
The worst retirement states for taxes – not what you thought
What are your thoughts and experiences about the worst and best states for retirement taxes? Please share them in the Comments section below.