The 10 Least Tax-Friendly States for Military Retirees

The brave veterans who stormed the beaches of Normandy, landed at Inchon, and fought in the jungles of Vietnam are senior citizens now. And many of them are living off military pensions. Are those pension payments taxed? The federal government taxes military retirement pay that's based on age or length of service (disability pensions might not be taxed). With state taxes, though, it isn't always so clear.

Unless otherwise noted, all income tax rates and thresholds are for the 2019 tax year.

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1. California

Courtesy Department of Defense

• Lowest tax rate: 1% (on up to $17,618 of taxable income for married joint filers and up to $8,809 for single filers)
• Highest tax rate: 13.3% (on more than $1,181,484 of taxable income for married joint filers and $1 million for single filers)

California offers retired military members no way to escape its high tax rates. The Golden State taxes 100% of a resident's income from military pensions, along with private, local, state, and other federal pensions. This applies to all military pension income received while a retiree is a California resident, regardless of where he or she was stationed while on active duty.

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2. Vermont

Courtesy Department of Defense

• Lowest tax rate: 3.35% (on up to $66,150 of taxable income for married joint filers and up to $39,600 for single filers)
• Highest tax rate: 8.75% (on more than $243,750 of taxable income for married joint filers and more than $200,200 for single filers)

The Green Mountain State taxes 100% of income from military pensions, along with most other sources of retirement income. The state also has a steep top income tax rate that could nick military retirees who have other sources of income.

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3. Washington, D.C.

Courtesy Department of Defense

• Lowest tax rate: 4% (on up to $10,000 of taxable income)
• Highest tax rate: 8.95% (on more than $1 million of taxable income)

Despite the large number of government workers who call it home, Washington, D.C., offers no tax breaks for those who decide to retire there. A $3,000 exclusion for government pensions, including military pensions, was repealed in 2015.

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4. Utah

Courtesy Department of Defense

• Tax rate: Flat tax of 4.95%

Utah doesn't offer any special tax breaks for military retirees, and its retirement-income tax credit is limited. Residents 65 and older are eligible for a retirement-income tax credit of up to $450 per person ($900 per married couple), but the credit is phased out at 2.5 cents per dollar of modified adjusted gross income that's more than $25,000 for singles or $32,000 for married people filing jointly.

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5. Arizona

Courtesy Department of Defense

• Lowest tax rate: 2.59% (on up to $53,000 of taxable income for married joint filers and up to $26,500 for single filers)
• Highest tax rate: 4.5% (on more than $318,000 of taxable income for married joint filers and more than $159,000 for single filers)

Arizona does offer a tax exemption for military pensions—but it's a relatively small one. The exemption is only good for up to $3,500 of military retirement income. Other states with broad-based retirement income exemptions provide a better tax break for retired veterans. Fortunately, Arizona's income tax rates are relatively low. That's the bright side.

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6. Montana

Courtesy Department of Defense

• Lowest tax rate: 1% (on up to $3,100 of taxable income)
• Highest tax rate: 6.9% (on more than $18,400 of taxable income)

The state provides an inflation-adjusted exemption for pension income (including military retirement pay), but veterans with a robust military pension probably won't qualify. For the 2019 tax year, the maximum exemption is $4,300. However, the exemption is gradually reduced to zero if federal adjusted gross income is between $35,800 and $37,950, regardless of filing status. (If both spouses receive pension income, married couples should check to see if each spouse could exclude $4,300 if separate returns are filed.)

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7. New Mexico

Courtesy Department of Defense

• Lowest tax rate: 1.7% (on up to $8,000 of taxable income for married joint filers and up to $5,500 for single filers)
• Highest tax rate: 4.9% (on more than $24,000 of taxable income for married joint filers and more than $16,000 for single filers)

The Land of Enchantment affords no special treatment for military pensions. People who are 65 or older may receive an $8,000 general income exemption, but to qualify, their adjusted gross income must be less than $28,500 for singles or $51,000 for married couples filing jointly. If you're at least 100 years old, all your income is exempt.

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8. Virginia

Courtesy Department of Defense

• Lowest tax rate: 2% (on up to $3,000 of taxable income)
• Highest tax rate: 5.75% (on more than $17,000 of taxable income)

Congressional Medal of Honor recipients don't pay Virginia tax on income from a military retirement plan. However, other retired veterans do pay tax on their military pensions. The state does provide an age-based deduction against all income that is available to anyone who qualifies. Seniors born on or before January 1, 1939, can deduct $12,000. For those born after January 1, 1939, who are at least 65 years old, the deduction is reduced by $1 for every $1 that federal AGI exceeds $50,000 (or $75,000 for married filers).

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9. Delaware

Courtesy Department of Defense

• Lowest tax rate: 2.2% (on taxable income from $2,001 to $5,000)
• Highest tax rate: 6.6% (on more than $60,000 of taxable income)

There are no special tax breaks in Delaware for military pensions. However, state law allows a modest exemption of up to $12,500 for pension and other retirement income paid to taxpayers age 60 and older (up to $2,000 for taxpayers younger than age 60). Eligible retirement income includes dividends, capital gains, interest, net rental income from real property and qualified retirement plans (e.g., IRAs, 401(k) plans, Keogh plans, and government deferred compensation plans). The general exemption is smaller than similar exemptions available in other states that do not fully exclude military pension income.

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10. Rhode Island

Courtesy Department of Defense

• Lowest tax rate: 3.75% (on up to $64,050 of taxable income)
• Highest tax rate: 5.99% (on more than $145,600 of taxable income)

The Ocean State exempts some retirement income from state taxes, but a military retiree who has income from IRAs or other sources could still get hit with a hefty tax bill. The first $15,000 of retirement income, including military pensions, is exempt from state income taxes for retirees who have reached full Social Security retirement age and who have income of up to $83,450 for single filers or up to $104,350 for joint filers (income thresholds are for 2019).

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