When It Comes to Choosing Your Best Place to Retire – The Most Important Financial and Tax Issue Might Not Be What You ThinkFinancial and taxes in retirement
By Mike Brady
The power of cocktail party conversations should not be underestimated. Countless decisions on investments and other matters have their roots in the chit chat made over a glass of chardonnay and mustard soaked mini hot dog roll. But when it comes to choosing a retirement location, this advice could be hazardous. The financial and tax issues that affect retirement choices are particularly difficult and confusing, yet of critical importance. This article is intended to help you identify and prioritize them.
Choosing a location as a great place to move for financial reasons based on one piece of information might be a very big mistake. For example, an individual might hear that retirement income is not taxed in a state, or that the state has a low tax rate. The reality might be that real estate taxes there are much more important in determining your overall costs. There are other factors to consider as well such as sales taxes, local income taxes, personal property taxes and other fees, and taxes on the retiree’s estate upon death. We will explain them below; we have also provided a Retirement Locations Tax and Home Comparisons” worksheet which you can use to summarize and compare relevant information for retirement destinations.
#1 Financial Issue – Cost of Real Estate and Property Tax
The cost of housing and related real estate property taxes are typically the most significant factors in determining the cost/benefits of moving to a particular location. For most people, these costs are usually far more important than income or sales taxes. For example, if you currently live in New Jersey, the Zillow Home Value Index there was $270,100 in 2011, and the per capita property taxes was the highest in the nation at $2,372 (in 2006, the latest year this data is available) . Contrast that with Alabama, where the Zillow Home Value Index was $102,500 and the per capita property taxes were $495 in 2008. Perhaps this is an extreme example, but if you own the “median” home in NJ you could theoretically sell it, move to AL, buy the “median” home there – and still have $167,600 in your pocket. You will also see your per capita property tax decline by almost $1900/year. No other tax saving could come close to the positive effect of these 2 factors.
To help you find this information there are numerous sources such as Zillow, Trulia, and Realtor.com that provide listings, historical transaction prices and indexes that can help a retiree get a sense of overall home prices and real estate taxes. If a retiree invests the time to visit multiple properties in selected retirement destinations, relative real estate values and taxes become clearer. Real estate taxes can differ greatly across localities and depend on the property value, assessed value, tax rates and the detailed rules for computation. It is a good idea to keep a record of real estate taxes for properties visited and this will help you understand and compare the tax burdens for various localities.
State Income Taxes
State income taxes can be a significant factor in certain circumstances. There are some key factors to consider beyond the actual rates a state applies to taxable income such as the following:
Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) do not have an income tax. Two states (New Hampshire and Tennessee) tax only interest and dividend income.
States have many tax breaks for income from social security, pensions and other retirement income sources. Pensions and retirement income can include federal civil service pensions, military pensions, in-state local and state pensions, out-of-state local and state pensions, railroad pensions, private pensions, and 401k and IRA distributions. The rules for taxing these various sources are different across the states so this can be complicated. This income tax Addendum provides more information on this topic.
Many states have provisions that can lower the tax bill for retirees such as deductions for taxpayers over 65 years old, standard deductions and personal exemptions.
An easy and accurate way to determine the state income tax burden is to ask your tax preparer or financial planner to do a “pro forma” based on your situation to give you an estimate of taxes for a given location.
For those of you who want to explore this on your own, each state has a web site that contains these rules. You can use this “Retirement Locations Tax and Home Comparisons” worksheet to summarize and compare relevant information for retirement destinations. The worksheet has been partially populated for Williamsburg, Virginia and Myrtle Beach, South Carolina. There is also a column for your present residence so you can understand how your present level of costs will compare with your retirement destination. You can customize it to add other factors that might be pertinent, such as home owners insurance.
The majority of states have no estate tax and those that do have exemption amounts. Only three states (New Jersey, Ohio and Rhode Island), have exemptions of under $1 million. There also seven states (Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania) that have an inheritance tax. NJ has both! While these taxes may not be a factor for many people, it is something that should be understood, particularly for a high net worth individual. If you Google on state inheritance and estate taxes you will be able to get detailed information related to these matters in the various states.
Sales and Personal Property Taxes
Sales taxes are imposed by states and localities at various rates and certain purchases are exempt from sales tax. Many local governments also tax the personal property of individuals and can impose other fees. It is a good idea to understand these taxes although in most cases differences will not be significant enough to change your mind about moving to a location versus another.
Pulling it all together
Except for very wealthy people or those with considerable pension income, the #1 financial consideration for choosing a retirement state or city for most people is not income taxes. Rather, it is the relative value of real estate and associated property tax. The crazy quilt pattern of exemptions, tax rates, and a lot more make it impossible to say with authority that one state is a low-tax state – for everybody. Each person’s situation is so different that would be an over-generalization.
This information is subject to change and the author and publisher are not responsible for any variations from the information contained herein. The information is given with the understanding the author and publisher are not engaged in rendering legal, tax or other professional advice.
Comments Anyone? What do you feel are the biggest financial determinants of retiring to another state? Do you have a “best” and “worst” candidate? Let us know in the Comments section below.
For further reference:
See State Income Tax Addendum for more details. Use our “Retirement Locations Tax and Home Comparisons” Excel worksheet to help you assemble, understand and compare the tax information. Here is the worksheet in a pdf.
10 Worst States for Retirement – 2011
Not What You Thought: The Worst Retirement States for Taxes
Most Tax Friendly States
Five Reasons Why You Should Retire to Another State
About the Author: Mike Brady is a former partner with Deloitte and Touche. He has served as a financial executive with a number of companies and is now a private consultant.