May 10, 2011 — Late last year our list of the “10 Worst Retirement States” caused a surprising uproar. Much excellent discussion came from it, and the experience gave us a new appreciation for the complexity of assigning factors to any “best” or “worst” list. Six months later, and with fresh data in from the Pew Center on the States, it seems like it’s time for an update. This article will list the states that are in the most fiscal trouble from the Pew Center’s viewpoint. In the second part of the article we will provide a recap of how these poor performing states stack up when it comes to taxes for retirees. We will not include any rating for weather/climate, as we did in last year’s list. Climate is so personal and so widely understood that we don’t feel the need to rate that factor for you.
The Pew Center recently published data on the unfunded liabilities of the states, The Widening Gap, for pensions and for promised future health care. The results are frightening, and carry broad implications that could affect your retirement if you live in one of these states (but more about that later). Although a few states are beginning to take action, the vast majority of states have chosen to ignore their looming pension problems. Many of them also have large deficits, which are equally as concerning. As we will see, most but not all of the states in trouble are low-tax states; some might argue that unwillingness to raise taxes has contributed to the mess some states are in. Here are some of the Pew Center’s findings:
As of Fiscal Year ’09 the states had a $660 billion
shortfall in the funding of their future pension obligations. Only 3 states had fully funded pension plans: New York, Washington, and Wisconsin. Listed below are the states with the lowest percentage funding for their pensions in FY 2009 (Note: the Pew Center says a healthy state should be 80% funded):
Illinois 51% funded
West Virginia 56%
New Hampshire 58%
Rhode Island 59%
Note: Partial data is available for FY 2010; it shows Connecticut as joining this list at 53%, while Kentucky and Louisiana’s conditions worsened to 54% and 56% respectively.
Health Care Funding – the Sleeping Giant
The states have about the same funding deficit when it comes to funding their promised
future health care benefits for retired employees – $31 billion is funded of their $635 billion obligation, leaving a shortfall of $604 billion. Only 7 states have funded at least 25% of their estimated future health care expenses (AK, AZ, ND, OH, OR, VA, WI). Note that Alaska is the only state on the list of low funded pension obligations that has substantially funded its future health care benefits.
Along with pension and health care underfunding, chronic budget deficits are another major issue that make a state an unfortunate choice for retirement. According to the Center for Budget and Policy Priorities, these are the states with the highest projected FY budget shortfalls, expressed as a percentage of their FY 2011 budgets:
Future effects on retirees
The effects of these combined future liabilities is unclear. A few states are addressing the problem by reducing promised benefits to their workers, lowering future benefits, raising taxes, or increasing benefits funding. Without changes, a future reckoning could be severe. Services like transportation, Medicaid, education, social services, etc. might have to be cut. Unless slashing spending can solve the problem, taxes will have to be raised. Those actions in turn can cause ripple effects – like people and businesses leaving the state, unhappy civil servants, declining property values, unemployment, and citizen unrest. All of which raises the question for you – do you want to retire in a state that is going to face a fiscal reckoning?
Taxes on retirees and the Pew’s bottom 8 states
In this section we will examine the tax situation for the 8 states in the worst shape for funding their future retirement obligations. Some of the 8 are decidedly more tax-friendly to retirees, as you will see. Data source is the Tax Foundation.
Illinois – Does not tax pensions or social security. 10th highest state for property taxes. Income tax rate was raised to 5% in January, 2011 as a partial response to the crisis, as were business tax rates. Sales tax on high side at 6.25%. Note: Several large IL corporations including Sears threatened to move out of the State as a result of the tax hikes.
West Virginia – West Virginia is one of 14 states that tax social security income. Income tax has its highest bracket at 6.5% and ranks 19th highest among states that collect income tax. Sales tax is slightly above the national median at 6%. Property taxes are low – WV is ranked 44th highest state for per capita property taxes. No inheritance or estate tax.
Oklahoma – This state has a top income tax rate of 5.5%, which starts with incomes of $8,700. The sales tax is below average at 4.5%. Property taxes are among the lowest in the nation. Social security income is not taxed – good news for retirees.
Kentucky – The state’s highest income tax bracket of 6% kicks in at $75,000. The sales tax is also at 6%. Kentucky ranks 45th for property tax collections. Kentucky does not tax social security income.
New Hampshire – The Granite State has a reputation as a low tax state. The income tax is a flat 5% and is only based on interest and dividend income (so pension and social security income is not taxed). It is one of the few states with no sales tax. Property tax, is however, another story. NH is the 3rd highest state for per-capita property taxes paid.
Rhode Island – By any definition the Ocean State is a high-tax state for retirees. It is one of 5 that does not exempt any type of pension income, including social security, from taxation. The top income tax rate is 9.9%. Property tax paid per-capita is 7th highest in the nation. There is an estate tax. The sales tax is above average at 7%.
Louisiana – This is another very tax-friendly state for retirees. The overall tax burden rank is 42nd out of the 50 states. The top income tax rate is 6%, which begins with incomes over $50,000. Social security income is not taxed, nor are public or military pensions. A portion of private pensions is exempt. The sales tax is 4%. There is no inheritance or estate tax. Property taxes are very low and people over 65 can apply for an exemption.
Alaska – Alaska is the lowest tax state, thanks to its vast energy reserves. Not only is there no income or sales tax, but the state actually pays a stipend to each and every resident. On the other hand, AK has the highest cost of living of any state.
There are many good reasons for choosing or avoiding a particular state for retirement. Climate, recreational and cultural opportunities, infrastructure, and proximity to relatives and friends are among those. We also believe that the fiscal condition of a state and its taxation of retirees are important considerations when it comes to your future well-being. Any of the states on the Pew pension and benefit problems list above might have the will and the resources to correct those problems. But if they don’t, you should be prepared for trouble ahead.
For further reference:
Worst States for Weather and Natural Disasters
Best States for Retirement – 2011 Edition
Worst States for Retirement – 2010
Most Tax Friendly States for Retirement
State Guides to Retirement
What do you think?
Do you agree with this list? Any additions or subtractions? What do you think are the worst states for retirement? Use the Comments section below and let your fellow members know.