As a financial advisor, I’m often asked about the best places to retire. I welcome the question, as one of the key considerations in planning your retirement is deciding where you will live.
The choice of where to retire is largely based on personal preference: You may pick a location to be near family and friends or you might pick a location based on your hobbies and what you enjoy. You may move or you may stay put. You can design your retirement to suit you, and the variety of factors at play are not all readily subject to quantitative analysis. However, you can analyze the tax consequences of where you choose to live. States have widely varying tax laws that each affect your money in different ways.
These same tax implications also apply throughout your working years, of course, and are probably even more important during your high-income and high-spending years. Often, though, younger people wind up needing to live where the best jobs are and may not have much choice in the matter. Still, if you’re just starting out, it’s useful to be aware of the tax impacts of the place you decide to settle in.
While your income will probably be lower in retirement after you stop working, you still may have a level of taxable income, as a result of taxable distributions from individual retirement accounts (IRAs) or 401(k) retirement plan accounts (including annual required minimum distributions), Social Security income, other pension income, or income from your taxable investment portfolio. Minimizing taxes on this income during retirement is important in making your retirement savings and investments last as long as possible or grow for your heirs. Federal income tax is the same in all fifty states, but each state has a different income tax structure and tax rate schedule.
Seven states currently have no income tax:¹
Two states do not tax wage and salary income, but do tax investment income (interest and dividends):
New Hampshire’s tax on interest and dividends is 5 percent. Tennessee is phasing out its interest and dividend tax, which is set at 2 percent for 2019, 1 percent for 2020, and eliminated beginning in 2021.²
With these tax levels in mind, it’s worth considering if you might enjoy retiring to Miami, Austin, Las Vegas, Nashville, Seattle, or Jackson Hole. If not paying state income tax appeals to you, then these cities need to be on your list for further reconnaissance.
The other forty-one states all have some form of income tax. Some have a single tax rate for all income, also known as a flat tax, but most states have a graduated tax rate schedule with increasing tax rates on higher amounts of income, similar to the federal income tax system. For example, Colorado has a flat tax of 4.63 percent while Arizona has a graduated tax rate schedule that tops out at 4.54 percent on taxable income greater than $155,000 (for 2018). You might consider those reasonable tax rates for two popular western states. On the other end of the spectrum, the five states with the highest income tax in 2018 included California with a top rate of 13.3 percent on income over $1 million, Hawaii at 11 percent on income over $200,000, Oregon at 9.9 percent on income over $120,000, Minnesota at 9.85 percent on income over $160,020, and Iowa at 8.98 percent on income over $71,910. Of course, each of these states has a full schedule of tax brackets and the amount of tax you pay depends on how much income you have in each tax bracket. When reviewing various tax structures and tax rate schedules, remember that in retirement, you’ll most likely have less income and be paying tax in lower rate brackets.
To fund their operations, states rely on a combination of taxes, including individual and corporate income tax, property tax, sales tax, tolls, excise tax (for example, on alcohol and cigarettes), estate tax, and others. States vary widely in overall tax policy, choosing the type of taxes collected and the amount of tax collected from each source to suit their residents. These additional policies, beyond income tax, will also likely impact your money and may influence where you decide to retire.
For example, four states have no state or local sales tax, including Delaware, Montana, New Hampshire, and Oregon.³ The five states with the next lowest sales tax rates in 2018 were Alaska (1.76 percent), Hawaii (4.35 percent), Wisconsin (5.42 percent), Wyoming (5.46 percent), and Maine (5.5 percent). The states with the highest sales tax rates in 2018 included Louisiana (10.02 percent), Tennessee (9.46 percent), Arkansas (9.41 percent), Washington (9.18 percent), and Alaska (9.10 percent). Note that three of the states with no income tax are in the top five of highest sales tax.
State taxes may not be the only factor—or even the biggest factor—when considering retirement destinations, but these laws will affect your savings and investments in real ways. When deciding where you want to spend these years, be sure to consider the full range of location-specific taxes. The financial implications could affect your level of security and freedom and ability to pass on wealth.
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1. All States Quickfinder® Handbook, 2018 Tax Year, Thomson Reuters.
2. Hall Income Tax Notice, Notice #17-09, Tennessee Department of Revenue, May 2017.
3. Facts and Figures: How Does Your State Compare, Tax Foundation, 2018.