States Lower Taxes to Court Retirees

Maryland is known as the Free State, reflecting its tradition of political freedom and religious tolerance, along with its resistance to Prohibition. Talk to retirees, though, and they’ll tell you the nickname is a misnomer, at least as far as taxes are concerned. While Maryland excludes from taxes up to $31,100 in income from pensions and 401(k) plans, state and local taxes on other types of income—including distributions from IRAs—can run as high as 9%.

Fortunately for Marylanders willing to relocate, a number of other states give retirees a break. For example, nearby Delaware and Virginia are both friendlier to tax-conscious seniors, according to Kiplinger’s state-by-state guide to taxes on retirees. Alternatively, Marylanders can join the thousands of retirees that have stowed their snow shovels and moved to Florida, which has no income tax and is on Kiplinger’s list of most-tax-friendly states.

Maryland Governor Larry Hogan says high tax rates are driving out lifelong Marylanders who still have much to offer the state besides a steady stream of tax revenue. Hogan, a Republican, has introduced legislation that would eliminate state taxes on the first $50,000 of income for retirees making up to $100,000 in federally adjusted gross income. Retirees with income of $50,000 or less would pay no state tax. Hogan also wants to exempt from tax all pension and retirement income paid to veterans and first responders. The tax cuts, which would cost an estimated $1 billion, would be phased in over five years, beginning in fiscal year 2022.

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The legislation faces an uncertain future in the state’s Democratic-controlled general assembly, where lawmakers have raised concerns about how the state would make up the revenue from the tax reductions.

Other states are also looking at ways to keep retirees from decamping to lower-tax states. Illinois Governor J.B. Pritzker recently signed legislation that will make it easier for seniors in Cook County—which includes Chicago and is the state’s most populous jurisdiction—to apply for a property tax break of up to $8,000 a year. Kiplinger has designated Illinois as one of the least tax-friendly states for retirees, primarily because of its sky-high property taxes. West Virginia, which gets a “mixed” rating from Kiplinger for the way it taxes retirees, is phasing out taxes on Social Security benefits over three years, starting in 2020. In New Mexico, which also gets a “mixed” rating, lawmakers are considering several bills that would repeal or reduce taxes on Social Security.

The Gray Migration

States where the most retirees are moving, based on the number of people age 60 and older who moved into a state versus the number of people who moved out.

Source: SmartAsset analysis of 2017 census data

Even states that already have low taxes are looking at ways to become more appealing to retirees. For example, Arizona Governor Doug Ducey’s proposed budget for 2020 would eliminate state income taxes on military pensions. Arizona is one of Kiplinger’s most tax-friendly states for retirees.

Economic benefit or burden? The independent research organization Think New Mexico contends that eliminating or reducing taxes on Social Security benefits would give retirees more money to spend, which would boost New Mexico’s economy. Think New Mexico estimates that every dollar of Social Security income generates about $1.71 in spending on food, clothing, transportation and health care.

But reducing taxes on retirees could force states to make costly trade-offs, some tax analysts say. States with a large number of retirees could see a significant reduction in their tax base, forcing them to cut services or raise taxes on their younger residents, says Kim Rueben, Sol Price fellow at the Tax Policy Center.

“There are good reasons to want people who have spent their lives living and working in the state to stay there,” says Jared Walczak, director of state tax policy for the Tax Foundation. But “as much as it’s great to know that you’re a state that retirees want to live in, it imposes a significant cost on the rest of the population.”

It’s also unclear how much state taxes influence retirees’ decisions when it comes to choosing a retirement destination. Proximity to family, the quality of health care and the cost of housing also play roles. “People make decisions about where they’re going to live for a whole host of reasons, and taxes are not the major one,” Reuben says.

Whether you’re planning to stay put when you retire or move somewhere else, it’s important to include the cost of federal and state taxes when estimating your retirement budget. State taxes are all over the map: Some states exempt a significant amount of income from retirement plans and pensions, while others provide few breaks for retirees. Property taxes, sales taxes and gas taxes can also take a bite out of your budget. Some states also have estate and/or inheritance taxes, which could reduce the amount of money you leave to your children.