September 6, 2011 – It’s pretty well known that some states are definitely harder on retirees than others when it comes to taxes. So we confess that when we set out to research this article on the worst retirement states for taxes, we had some pretty strong preconceptions. Most of the worst tax states would be in the Northeast, we assumed, with perhaps California thrown in for a little geographical balance. Boy were we wrong – all but 3 of the states on our list are west of the Mississippi.
First, a few caveats about our list of worst tax states for retirement. It is easy to generalize about taxes, but that would be a huge mistake. The more we analyzed the topic, the more complicated it got. To begin with, there are many different kinds of taxes: income, sales tax, property taxes (at the state and local level), inheritance, estate, and incidental taxes like those on cigarettes and gasoline. Depending on individual situations, one type of tax will have a larger impact on one retiree than it will on another. Many states have attractive exemptions for certain kinds of income (such as military or government pensions) which will be of great value to one group of retirees, but not to another. Our list is mostly based on income taxes.
To determine our rankings we used 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. We arbitrarily did a rough computation of income taxes for 2 income levels: $60,000 and $100,000, to which we took 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. Lastly, please remember that taxes are only one reason to select or reject a retirement state. In our opinion, there are many other, better reasons to choose a retirement state (see “What Betty and Jim Learned Looking for Their Best Place to Retire”. Lastly, see the additional list of qualifications at the end of this article.
Narrowing Down the List
Any state with an income tax makes the first cut for worst retirement tax state (there are 43 of those, although New Hampshire and Tennessee only tax dividends and interest). States that tax either all or part of social security income at the state level are certainly candidates too (most states don’t). States that tax pensions are obvious contenders. States that tax both pensions and social security are the worst places for retirement taxes, since these are two of a typical retiree’s major income sources.
The 2011 List – Worst Tax States for Retirement
The following is our list of the worst states for retirement taxes, with the priority on income taxes. The states on this list are here primarily because they do not have meaningful exemptions for social security and/or pension income. It is actually pretty obvious – if social security, pensions, and retirement income can be excluded – retirees’ taxes will be a lot lower they are for working people.
The approximate income tax on our couple’s hypothetical income of $60,000 was $2911 after all known exemptions were taken. That made it the highest of any state we did calculations on. At $100,000 the state income tax would be $5732. The state does not exempt social security income from taxation. The MN sales tax is 6.875%.
At $60,000 our couple would pay $2654, and at $100,000 their payment would be $5415. MT taxes social security income. However, Montana has no sales tax, which is a consideration in Montana’s favor (assume that you spend $10,000 on taxable purchases. At a 5% rate, that amounts to $500/year in sales tax).
The taxes in the Show Me would be approximately $2415 on a $60,000 income and $4659 at $100,000. MO taxes social security income. Missouri has a fairly low 4.225% sales tax.
After exemptions, the tax would be $2155 on $60,000 income and $4155 on $100,000. Social security income is taxable in UT. Utah’s sales tax is 4.7%.
Our couple would pay $1903 on a $60,000 income and $4534 on $100,000. Nebraska does not exempt social security or most pension income. The sales tax is 5.5%.
6. West Virginia
The state income tax on $60,000 would be $1577 and $4077 on $100,000. WV’s sales tax is 6%. Beginning in 2020, taxation of Social Security benefits will be phased out over 3 years.
7. Rhode Island
Although RI is generally regarded as a high tax state, its generous exemptions mitigate that somewhat for retirees. Taxes would be $1425 and $3155 on incomes of $60,000 and $100,000. There is a 7% sales tax. Ominous for the future, capital gains begin being treated as ordinary income in 2010. Social security and pension income is generally not exempt.
The tax on our hypothetical income mix of $60,000 would be $1340 and $3338 on $100,000. Social security and pension income is generally not exempt. There is a 6% sales tax.
If Adjusted Gross Income is less than $75k social security income Is exempt in this state. Income taxes on $60,000 would be $974 and $4718 on $100,000. The Kansas sales tax rate is 6.3%.
After all known exemptions are taken our couple would pay $1326 and $3176 on incomes of $60,000 and $100,000. On the plus side for Colorado’s property taxes, 50% of up to $200,000 in property valuation is exempt for qualified seniors. The state has a low 2.9% sales tax, although municipalities often make the effective rate much higher.
An illustration of the importance of social security and pension exemptions
New Jersey is regarded as the highest tax state in the nation. But when it comes to income tax paid by retirees, NJ is a pushover, thanks to its policy of not taxing social security income and providing generous pension exemptions for incomes under $100,000. Our hypothetical couple would only pay $280 and $753 on incomes of $60,000 and $99,999. Property taxes are another matter however.
Please take the rankings on this list as an approximation. To develop these figures we used readily available information on the web – we are not tax professionals and our calculations could be flawed. Information on the web about state tax rates and exemptions is complicated and sometimes contradictory. In addition to those concerns, please recognize that if you or our couple had a different mix of income sources (the same amounts, but more from pensions, for example), the results and rankings would be very different. The best way for you to find out your worst retirement states for taxes is to visit the websites of those states, call them or consult a tax professional, and then determine how they would tax your income sources.
Please note the states are a maze of exemptions and qualifications. For example your military or government pension might be taxable in one state, but not in another. In and out of state pension income is often treated very differently. Distributions from 401k or other retirement plans might be taxable in one state and not in another. There might be an exemption for federal tax paid, or not. A state like Connecticut has very high standard exemptions, while one like Kansas exempts very little. Before you make any significant move based on taxes, make sure you research the subject thoroughly and discuss it with your tax professional.
If you own your own home there is a very good chance that the largest tax you pay will be for property taxes. The states with the highest property taxes are New Jersey, Connecticut, New York, Massachusetts, Rhode Island, New Hampshire, and Illinois (all of these states have median property taxes over $3000). Of course these states also tend to have some of the highest property values of any state. Here is a link to the Tax Foundation’s state rankings of property tax paid.
For further reference
2011 Worst States for Retirement
Best States for Retirement 2011
Best States to Die in: Inheritance and Estate Taxes
The Tax Foundation -Tax Burdens by State is an excellent source of information about the relative tax burden for different states. However you should remember that their rankings might not apply to retirees, who have different sources of income along with different exemption possibilities.
RetirementLiving.com was our source for much of the information about exemptions and what is and is not taxed. It’s a great resource.
The Most Tax Friendly States
What do you think about this list, and how it might apply in your situation? Would you consider moving to another state to save money on your taxes? Do you come up with different taxes owed for our examples? Please let us know using the Comments section below.