TAXES


Tax-Friendly Places to Retire

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.

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.

However, in 2009, if you don’t itemize, you can boost your standard deduction (usually $11,400) by up to $1,000 for property taxes paid on your principal residence, if you are married and file a joint return. Single taxpayers who claim the standard deduction can boost their $5,700 write-off by up to $500. 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. State tax revenues plunged nearly 12% during the first three months of 2009, the sharpest decline on record, reports the Nelson A. Rockefeller Institute of Government. And it may take states years to make up the shortfall.

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Despite the dismal economy, there is one bright spot for retirees on the move: falling home prices. “We see exceptional opportunities in some sought-after retirement destinations,” says Mary Lu Abbott, editor of Where to Retire magazine (www.wheretoretire.com). If you thought locations such as Naples, Fla., Scottsdale, Ariz., and Hilton Head, S.C., were out of your price range, it could be a good time to take a second look. Property taxes, however, have not been moving down as quickly.

For a state-by-state tax guide, including special exemptions for seniors and a rundown on how various types of retirement income are taxed, see our interactive retiree tax map.

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, ten states—Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania—exclude all federal, military and in-state government pensions from taxation. But Kansas taxes public pensions from all other states. Pennsylvania and Mississippi, by contrast, exempt all retirement income—including distributions from IRAs and 401(k) plans.

Some states have special breaks based on age or income. For instance, New Jersey allows residents 62 and older with incomes of $100,000 or less to exclude up to $20,000 of private-pension income from taxes. New York allows residents 59½ and older to exclude up to $20,000 of private or out-of-state public pensions from taxes, regardless of their total income. In Michigan, individuals can exclude up to $43,440 of private-pension income ($86,880 for married couples) from state taxes in 2009.

Three states are particularly tough on retirees. Not only do they fully tax most pensions and other retirement income, they also have high top tax brackets: California (9.55% on income less than $1 million), Rhode Island (9.9%) and Vermont (9.5%). Connecticut and Nebraska also fully tax retirement income, with top rates of 5% and 6.84%, respectively.

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