What are the most tax-friendly states for retirees

It’s less taxing to retire to Wyoming.

While retirees flock to Florida in part for its tax-friendliness, those who really want to save big on their tax bill may want to head west. An analysis released this week by the personal-finance publisher Kiplinger revealed that the state of Wyoming was the most tax-friendly for retirees.

“For Wyoming, it starts with the fact that there is no state income tax,” explains Rocky Mengle, the tax editor at Kiplinger. That means the state does not tax Social Security benefits, pension income, 401(k) plan withdrawals and IRA distributions, or other income. “You can’t beat that,” he says, adding that property and sales taxes are also relatively low in Wyoming. “When you add it all up, Wyoming offers retirees the most tax-friendly environment around.”

The Kiplinger analysis looked at the estimated state and local tax burdens in each state for a hypothetical retired couple who had income from Social Security, an IRA, a private pension, interest and dividends, and capital gains. This couple also had a $400,000 home with a small mortgage and $10,000 in deductible medical expenses.

Other states that are very tax-friendly include Nevada and Florida, which don’t have income taxes, and Tennessee, whose income tax is only assessed on interest and dividends, explains Mengle. The remaining states exempt Social Security benefits from income taxes. Mengle adds that, “oddly enough, out of the 10 states with the highest sales taxes by our calculations, five are also on the retirees’ most-friendly list,” noting that, while this matters, “sales taxes tend to have the least overall impact on a retiree’s overall state tax burden.”

The 10 most tax-friendly states for retirees:

1. Wyoming2. Nevada3. Delaware4. Alabama5. South Carolina6. Tennessee7. Mississippi8. Florida9. Georgia

10. Arizona

Meanwhile, Nebraska takes the cake as the least tax-friendly state for retirees, according to the analysis, which Mengle admits is likely to surprise people. “In Nebraska’s case, high income taxes and property taxes make it hard on retirees living there,” he says, adding that the state also taxes Social Security benefits for many of its retirees and does not offer an “exemption — like you see in many other states — for other types of retirement income,” among other tax-related issues.

The 10 least tax-friendly states for retirees:

1. Nebraska2. Connecticut3. Kansas4. Wisconsin5. Minnesota6. Vermont7. Rhode Island8. New Jersey9. Illinois

10. New York

One big factor that will land you on the least friendly list is how the state treats Social Security benefits and other retirement income, Mengle explains. Rhode Island, Vermont, Minnesota, Kansas, Connecticut and Nebraska, for example, at least partially tax Social Security benefits for some of their residents. Many of the other states on the list, notably New Jersey, Connecticut and Illinois, have high property taxes.

It’s important to point out that this list of the most and least friendly tax states for retirees would look different if they chose a different hypothetical retired couple for their model. And, as we know from those who live in Florida for part of the year, snowbirds can ease their tax burdens if they’re well-versed in the tax laws of both states in which they reside.

Choosing where to live in retirement isn’t an easy decision since there are so many factors to consider. The top priorities for those contemplating retired life are often the desire to live in close proximity to family and friends, to relocate to a place with warmer temperatures, to reduce housing expenses, and to have access to quality healthcare —or a combination of all the above.

While all the aforementioned criteria are admirable, one often overlooked consideration is taxes. The total state and local tax burden can be thousands of dollars more per year in one state versus another. Therefore, having a high-level understanding of your potential tax bill, especially if your retirement funds are limited, is critical and should factor into your decision-making process. 

The most tax-friendly states aren’t the same for everyone

The list of the most tax-friendly states will, to an extent, vary based on the retiree’s specific financial circumstances. That decision will involve several variables, such as the sources of their retirement income, the dollar amount of their income and the value of the assets they want to leave for their heirs.

The Social Security Administration recently claimed that 21% of married couples and about 45% of unmarried persons rely on Social Security for 90% or more of their income. If you fall within this category during retirement, then the most tax-friendly states from your perspective could be the ones that don’t tax Social Security income, especially if you don’t have significant assets to leave to your heirs. In this scenario, you’ll have a broader selection of retirement options since there are currently 38 states that don’t tax Social Security benefits. Only Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia currently tax Social Security income to varying degrees.

States that won’t tax your retirement income

You’ve worked hard to build your retirement nest egg; therefore you want to pay as little in taxes as possible when you begin accessing your retirement funds. Fortunately, there are some states—nine to be exact—that don’t tax retirement income at all. In fact, they don’t charge state tax on any other income, an important consideration for those who may want to continue working some during retirement. In addition, these states don’t levy any estate or inheritance taxes, allowing you to leave more for your heirs.

The nine states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. Therefore, if you’re retired in one of these states and take a distribution from your IRA or 401(k), or receive Social Security benefits, a pension or even generate investment income, the state tax collector won’t take a single penny (federal taxes still apply). As a result, for many, these nine states are the most tax-friendly for retirees.

Browse the Internet and you may also see Illinois, Mississippi, Pennsylvania, and the state of Washington on some most tax-friendly lists. We can’t argue they aren’t tax-friendly, but we took them out of our top nine since they may not be as friendly for some retirees. For example, pension and 401(k) income must be from a qualified employee benefit plan in order to be tax-free in Illinois. They also charge an estate tax for estates worth more than $4 million. Mississippi will take its share of IRA, 401(k) or pension income if you retire early (before 59 ½ years of age) and Pennsylvania charges an inheritance tax and also taxes retirement income if you retire early. All other states tax retirement income at varying degrees.

Other taxes to consider during retirement

Housing, which includes mortgage, rent, property taxes, insurance, maintenance and repairs, is the largest expense for retirees. More specifically, the average retiree household pays an average of $17,472 per year ($1,456 per month) on housing expenses which represent almost 35% of their annual expenditures. To help minimize these expenses, you should also consider property taxes when determining where you want to retire.

Hawaii, Alabama, Colorado, Louisiana and the District of Columbia were the five with the lowest property taxes, based on effective real estate tax rates according to WalletHub.  Here’s how the top nine states fared: Alaska (#33), Florida (#24), Nevada (#9), New Hampshire (#49), South Dakota (#35), Tennessee (#15), Texas (#45) and Wyoming (#10).  You should also review the average dollar amounts based on median home values to give you a ballpark number of what you’d be spending—these numbers are located on the same site.

The worst state to retire in, based on property taxes alone, is New Jersey. The state taxes at a 2.49% rate and the average property tax bill is $8,362. This dollar amount ranks it highest in the nation by over $2,500 a year.

For those of you who are (or will be) on a fixed income, every dollar counts. That’s why you may also want to review sales tax rates since you’ll likely spend a big portion of that income on taxable items. Five states don’t have statewide sales taxes; they are Delaware, Montana, New Hampshire & Oregon. Alaska doesn’t have a statewide sales tax, but the state does allow localities to charge sales taxes. The five states who charged the lowest combined rates are Alaska (1.76%), Hawaii (4.44%), Wyoming (5.34%), Wisconsin (5.46%) and Maine (5.50%), according to the Tax Foundation’s most recent data.

Where people are retiring to

If you aren’t a numbers person, perhaps another approach is identifying where people are retiring to and then research why. To give you a jump start, we crunched the numbers (based on five years of data from SmartAsset) and, no surprise, Florida is (and has been) the most popular retirement destination. It’s not even close.  

To illustrate, roughly 800,000 people ages 60 and older actually moved to their top 10 retirement destinations between 2015 and 2019 (their top 10 destinations varied slightly each year, based on the number of actual people within this age group moving). Almost 46% of those people ended up in the state of Florida.

Arizona ranked second at approximately 18%. The number of people relocating to Arizona represents more than twice as many people compared to those that relocated to North Carolina (8%), which often landed third on their lists. 

In sum: the most tax-friendly states to retire

Choosing where to live in retirement isn’t always an easy process. That’s because there are both financial and emotional decisions you’ll need to make. Hopefully, at the very least, the information in this post provided you with the additional insights to make a more informed decision.

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Disclosures
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.