Most retirement savers tend to focus on how much money they’re putting away for retirement and how much their investments are earning. These are certainly important factors when it comes to planning for a financially comfortable retirement.
But there’s another critical — and often overlooked— factor that’s just as important: taxes. Different states tax retirement, pension and Social Security income differently. There are also big differences in how states assess sales and use taxes and how localities assess sales and property taxes, especially on residential real estate.
These differences in taxation could have a big impact on your retirement finances, especially when it comes to how long your retirement nest egg lasts. So, it’s a good idea to do some research into state taxation before deciding where you’ll spend your golden years.
State taxation of individual income
There are currently seven states in which individual income is not subject to tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. In two other states — New Hampshire and Tennessee — only dividends and interest are subject to state taxes.
The tax treatment of retirement income varies considerably in all the other states. For example, 401(k), IRA and pension income is exempt from state tax in Illinois, Mississippi and Pennsylvania. In Alabama and Hawaii, pension income is exempt from state tax but income from 401(k)s and IRAs isn’t.
Many states exempt or provide a credit for a portion of pension income — they include:
- Alabama
- Arkansas
- Colorado
- Delaware
- Georgia
- Hawaii
- Iowa
- Kentucky
- Louisiana
- Maine
- Maryland
- Michigan
- Missouri
- Montana
- New Jersey
- New Mexico
- New York
- Ohio
- Oklahoma
- Oregon
- Rhode Island
- South Carolina
- Utah
- Virginia
- Wisconsin
The state income tax rate is another important consideration. In Arizona, New Mexico, North Dakota and Ohio, for example, marginal income tax rates are below 5%. Colorado, Illinois, Indiana, Michigan and Pennsylvania, meanwhile, each have flat tax rates below 5%.
Conversely, the highest state income tax rates are in California (12.3%), Hawaii (11%), New York (10.9%), New Jersey (10.75%), the District of Columbia (10.75%), Oregon (9.9%), Minnesota (9.85%), Iowa (8.53%) and Wisconsin (7.65%).1
State taxation of pension and Social Security income
Meanwhile, 13 states and the District of Columbia fully tax pension income:
- Arizona
- California
- Connecticut
- Idaho
- Indiana
- Kansas
- Massachusetts
- Minnesota
- Nebraska
- North Carolina
- North Dakota
- Vermont
- West Virginia
And 13 states also tax Social Security income:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- North Dakota
- Rhode Island
- Utah
- Vermont
- West Virginia
Some of these states that tax Social Security income provide tax breaks for low-income couples and individuals. Also, West Virginia started phasing out state taxation of Social Security benefits in 2021.
State, local sales and use taxes
State income taxes aren’t the only taxes that can affect your income in retirement. State sales and local sales and use taxes can also take a bite out of your retirement finances. All states and the District of Columbia impose these taxes except Alaska, Delaware, Montana, New Hampshire and Oregon.
The highest state sales taxes are in California (7.25%), Indiana, Mississippi, Rhode Island and Tennessee (7.0% in each). On the flip side, the lowest state sales taxes are in Colorado (2.9%), Alabama, Georgia, Hawaii, Louisiana, New York, South Dakota and Wyoming (3.0% in each). Local sales and use taxes, meanwhile, are assessed by cities, counties and special taxing jurisdictions. These vary widely across the country.
State and local property taxes
State and local property taxes are another important factor to consider. The biggest property tax paid by most retirees is the annual tax paid on the value of their home. However, some states and local jurisdictions offer property tax exemptions, credits and abatements to retirees, such as an exemption from paying the school tax portion of their property taxes.
Next steps for you
Retirement tax planning can be complicated, and the details vary from one individual or couple to the next. It may be a good idea to work with a tax advisor and personal financial planner for guidance in your specific situation.
Managing your tax situation is a year-round — and life-long — endeavor, but you can take a few actions now to get yourself on the right track
- Sign up for the Empower Personal Dashboard. Millions of people use these free and secure professional-grade online financial tools. You can use them to see all your accounts in one place, analyze your spending and plan for long-term financial goals.
- Consider talking to a fiduciary financial advisor and tax advisor for more detailed guidance on your tax optimization strategies.
