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Tax Planning

Retiree Tax Bite Varies By State

Whether you plan to relocate to a new state or stay put, make sure you understand how retirement income is taxed and what breaks you might be entitled to.

In planning for retirement, one key factor to consider is your state tax burden. Some states are tax-friendlier to retirees than others, but some states are also tax-friendlier to certain types of retirement income. Whether you want to retire to a new state or plan to stay put, it's critical to know how the state will tax your retirement income.

Kiplinger's annually updated State-by-State Guide to Taxes on Retirees can help. New this year: In addition to Social Security, we break out how states treat four other major sources of retirement income -- IRAs, 401(k)s and other defined-contribution employer plans, private pensions and public pensions. With the "compare" tool, you can select up to five states at a time to see how their tax burdens stack up side by side. For detailed information for each state, go to the guide.

Pensions and other retirement income. Retirement income of all kinds gets a pass in seven states. Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming have no state income tax. Two states, New Hampshire and Tennessee, tax only dividends and interest.

Of the remaining 41 states, plus the District of Columbia, that have an income tax, eight have a flat tax, which imposes a single rate on all residents regardless of income. The other 33 states, plus the District, impose graduated tax rates, which tax households with higher incomes at a higher rate.

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Most states offer some type of retirement-income exclusion. Mississippi, for instance, exempts all retirement income, including public and private pensions and distributions from retirement accounts, such as IRAs and 401(k)s.

Other states exclude a set amount of retirement income from taxation. These amounts vary greatly, from a few hundred bucks to thousands of dollars. Georgia offers the largest exclusion, at $65,000 for a taxpayer 65 or older (couples can exclude $130,000).

Some states offer tax breaks on certain categories of retirement income. Kansas, for example, exempts in-state public pensions but taxes all private retirement income. And two states offer a break only to military retirees: Connecticut excludes 100% of military retirement pay from tax, and Nebraska lets military retirees exclude part of military retirement income.

Social Security benefits. While the federal government taxes up to 85% of Social Security benefits, the majority of states exclude Social Security from income tax.

In addition to the nine states that don't have a broad-based income tax, Social Security benefits are free from state income taxes in Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin. D.C. also waives income tax on benefits.

Of the remaining 13 states, Social Security benefits are taxable to some extent. West Virginia, for instance, taxes benefits the same as the federal government does. So does Rhode Island for 2015, but starting in 2016, the state will bump the income thresholds higher than the federal threshold. Connecticut, Kansas, Missouri and Nebraska also have income thresholds that are higher than the federal threshold. The higher thresholds vary by state.

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Estate and inheritance taxes. The majority of states do not impose estate tax or inheritance tax. But 17 states and the District of Columbia have one or the other, and two states -- Maryland and New Jersey -- impose both levies. An estate tax hits the estate before assets are distributed, while an inheritance tax is paid by the heirs. Tennessee, which calls its tax an inheritance tax, imposes a tax on estates of more than $5 million in 2015, but will eliminate the tax in 2016.

Generally, state estate-tax rates are graduated up to 16% on the largest estates. That compares with the federal estate-tax rate of up to 40%. But exemptions in some states are lower than the federal estate-tax exemption, which for 2015 is $5.43 million. In New Jersey, for instance, the exemption is $675,000, which means that an estate that is exempt from federal estate taxes could end up with a state tax tab.

A couple of states have started to close that gap. New York, which has an estate-tax exemption of $3,125,000 as of April 1, 2015, will gradually raise its exemption until January 2019, when it's set to match the federal exemption in effect that year. Maryland will also lift the current $1.5 million exemption to match the federal exemption by 2019.