What Are the Best States to Retire Tax-Wise?

Matt Boyd is an assistant director of High Net Worth Tax Planning at Northwestern Mutual.

When it comes to planning your dream retirement, one of the big questions you need to ask is where you want to live during your golden years. You may be among those who are considering a retirement abroad. But even if you don’t plan to leave the United States, you may be thinking of retiring to a different state than the one you live in now. Perhaps it’s a place where you have spent vacations, or where family is located. As you’re weighing your options, there is one big factor for retirees to consider: taxes.

When you start looking, you’ll find that some states take a smaller bite out of your hard-earned nest egg than others. Here are some key factors to consider if you’re looking to determine the best states to retire to tax-wise.

Some states do not impose an individual income tax

By relocating to certain states, you can avoid state individual income tax entirely. States that do not impose an individual income tax include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming. Other states tax only limited income types—for example, New Hampshire only taxes interest and dividends, and Washington state only taxes certain capital gains (above a threshold). Among states that impose an income tax, the tax rate can vary significantly. For example, the maximum income tax rate in Arizona is 2.5 percent, while the maximum income tax rate in California is 12.3 percent.

How is Social Security income taxed?

Social Security is a significant source of income for most retirees. These benefits are generally subject to federal tax, depending on your total taxable income for the year (between 0 percent and 85 percent is taxed on the federal return). Most states exempt Social Security benefits from state tax. States that may tax Social Security benefits include: Colorado, Connecticut, Kansas, Minnesota, Montana, New Mexico, Rhode Island, Utah and Vermont. Even among these states, in some cases, there is an income-based exemption or deduction, so consider your specific circumstances.

How is other retirement income taxed?

Some states, including Alabama, Illinois, Mississippi, and Pennsylvania, exempt most distributions from retirement plans, including 401(k), IRA, and pension plans. Hawaii exempts most pension plan distributions, but not 401(k) and IRA distributions. Other states exempt military pensions. Many states provide an annual deduction against retirement income, with eligibility sometimes based on total income or age. Taxation of investment income also varies by state. Some states, including Wisconsin, Arkansas and North Dakota, provide a preferential tax on long-term capital gains. Depending on your specific type(s) of retirement income, a given state may be particularly suited to benefit you.

Other tax considerations

Income tax is not the only tax consideration for retirees. Taxes like sales tax and property tax also contribute to the overall tax burden of a particular state. For example, Alaska, Delaware, Montana and Oregon don’t impose a sales tax on consumers. Neither does New Hampshire, but it ranks in the top five for states with the highest property taxes, along with Connecticut, Illinois, New Jersey and Vermont.

Residency considerations

Each state has its own laws for when an individual begins residency or ends residency. Various factors are considered beyond where an individual is physically present. The location of a home, the location of family members, and the location of social and economic ties, may all be considered. This becomes more complicated when retirees split time between multiple states. Consult your tax adviser to determine both the tax impact of changing residency, and the specific actions needed to achieve a desired residency status.

Creating a financial plan

For most people, taxes are not the deciding factor for where they choose to live during retirement. Taxes are an important consideration, and reducing taxes creates opportunities, but taxes are just one factor in your overall financial plan. Determining how your nest egg is invested and quantifying your desired cost of living, also play a significant role in planning your retirement cash flow. A financial advisor can help you weigh your options and tailor a financial plan that empowers you to meet your retirement goals.

This article is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.