5 Tax Factors to Consider When Picking a Retirement Destination

Maybe you’re thinking about relocating in retirement, in hopes of enjoying milder weather and lower expenses. Before you make a move, it pays to assess the overall tax burden of your future home. Some states that are currently tax-friendly could get a lot less chummy as they scramble to find new sources of revenue to plug gaping holes in recession-shredded budgets.

The Kiplinger Retiree Tax Map -- All New for 2010! See How Each State Will Tax You in Retirement

No matter where you live, your federal taxes will be about the same. But you’d be amazed at how much your state and local tax burden may vary from one location to another. And if you itemize deductions, how much you pay -- and deduct -- in local property taxes could affect the bottom line of your federal return, too.

People planning to retire “often use the presence or absence of a state income tax as a litmus test for a retirement destination,” says Tom Wetzel, president of the Retirement Living Information Center (www.retirementliving.com). “But higher sales and property taxes can more than offset the lack of a state income tax.”

Seven states -- Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming -- have no state income tax. Two states -- New Hampshire and Tennessee -- tax only dividend and interest income that exceeds certain limits. But many of the remaining 41 states (and the District of Columbia) that impose an income tax offer generous incentives for retirees. If you qualify, moving to one of these retiree-friendly areas could be cheaper than relocating to a state with no income tax.

Plus, in tough economic times, states without a personal income tax have fewer sources of revenue and are more likely to raise property or sales taxes and other fees to shore up their budgets.

Here are 4 other key tax factors to consider when comparing states as possible retirement destinations:

Taxes on pensions

Although most states that impose an income tax exempt at least a portion of pension income from taxation, they often treat public and private pensions differently. For instance, some states exclude all federal, military and in-state government pensions from taxation. Other states go even farther, exempting all retirement income -- including distributions from IRAs and 401(k) plans.

Some states that do tax pension income offer special breaks based on age or income. Alas, several states are particularly tough on retirees, fully taxing most pensions and other retirement income.

Taxes on Social Security benefits

Depending on your income, you may be required to include up to 85% of your Social Security benefits in your taxable income when filing your federal return. But in recent years, many states have been moving away from taxing Social Security benefits. Only about a dozen states now tax Social Security benefits to some extent.

Sales taxes

Don’t forget to include state and local sales taxes in your personal budget analysis. Some states exempt food and medicine; other states famously have no sales tax at all, while some will tax every dime you spend.

And keep in mind the retail-tax pain doesn’t always stop at the state level. Most states allow cities and counties to assess their own sales taxes.

Property taxes

Property taxes are a major cost factor, particularly for retirees living on fixed incomes. But many local jurisdictions offer property-tax breaks to full-time residents, some based on age alone and others linked to income. Tax rates vary significantly from state to state and among cities in the same state.