November 18, 2020 — Although there are many good reasons to choose a state for retirement, for many well-heeled retirees, finding one without an income tax is right up there. Up until 2021, only 7 states could claim that particular attraction. But coming in 2021 an 8th will join the list, Tennessee (the State previously taxed dividends and interest, but not other income). Other states have made moves to make their tax situation more favorable in 2021 as well, mainly by increasing standard deductions and personal exemptions.
Starting in 2021 the eight states that charge no income tax will be: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. New Hampshire almost makes the list because it only taxes interest and dividends (up until 2021 Tennessee was in the same category).
For states that do have income taxes, finding the best deal is not that simple
The ways states set up their income tax structure is complex and confusing. So if you are considering several states for retirement and you have substantial income that could be taxed, do your homework – it’s not that simple comparing the various apples and oranges.
Some states are obvious very high tax. California, Hawaii, New Jersey, and New York qualify here – if you a high earner you could pay as much as 13.3% in CA on income over $1,000,000, 10.75% in NJ over $5,000,000, or 11% in Hawaii on $200,000 of income. NY’s max rate is 8.82% on income of just over $1,000,000.
Standard deductions and Personal Exemptions are another issue to consider. Some states have very generous standard deductions and/or personal exemptions that mean most retirees will not have to pay much, if any income tax. Arizona and Minnesota are two states that recently adopted the new federal standard deductions ($12,400/single, $24,800/couple). These deductions are much higher than these states offered in the past, meaning fewer retirees will have to pay state tax. Colorado, Idaho, Maine, Missouri, New Mexico, North Dakota, South Carolina, and D.C also have the higher federal deduction. Connecticut, Maryland, Rhode Island, and Vermont have generous Personal Exemptions that make those states similarly attractive to retirees with moderate income.
Flat rates vs. multiple brackets further complicate
Nine states including Illinois have a flat income tax rate – there is only one bracket. So in in IL you will play 4.95% on every dollar you earn after deductions and exemptions. That works out well if you are a high earner, but not so great on a percentage basis for lower earners. Indiana (3.23%), Kentucky (5%), Massachusetts (5%), Michigan (4.25%), North Carolina (5.25%), Pennsylvania (3.07%), Utah (4.95%) are other states with flat rates.
Other states have unusual brackets, such as Georgia’s regressive tax, where you hit the maximum bracket with income of $7,000. Compare that to New Jersey’s very progressive top bracket rate of $5,000,000.
We always urge people to retire where they want to, and not let the tax tail wag the dog. But if taxes are very important to you, comparing state income taxes is pretty simple if the state you are considering doesn’t have an income tax. In other states, it is not that simple, for the reasons stated above and many others like taxation of Social Security, pensions, etc. If taxes are an important driver in your retirement decision, the best policy is to have your accountant prepare a sample return for any state you are considering. Note: We used the Taxfoundation.org’s excellent article comparing various states tax schemes as the foundation of this article.
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