How State Taxes Can Affect Your Retirement

One way to help manage the challenge of providing a financially secure retirement is downsizing. For example, although the memories of raising a family may be hard to leave behind, you probably no longer need a big house and yard. In fact, it might be a burden to maintain them. In addition to the benefits of a smaller home, you might want to take into account how state taxes can affect  your retirement.

How state taxes can affect your retirement

Some states, in spite of their many attractions, can put a big ding in your retirement funds. If you plan to relocate, here are some of the most “tax-friendly” states for retirees:

10. Pennsylvania. Pennsylvania is one of only two states (Mississippi is the other) that exempts all retirement income — including public and private pensions, IRAs and 401(k) distributions — from its state income tax.

9. Delaware. The First State is number one with many retirees, thanks to low real estate taxes, modest income taxes and no sales taxes. In fact, its highway billboards welcome visitors to the home of tax-free shopping. Social Security benefits are exempt from income taxes, and residents 60 and older can exclude $12,500 per person of qualified pension benefits and investment income, including dividends, interest and capital gains, from income taxes.

8. Louisiana. For retirees, every day is like Mardi Gras in Louisiana. Social Security and military, civil service, and state and local government pensions are exempt from state income taxes, plus up to $6,000 per person of pension and annuity income.

7. South Carolina. South Carolina extends its Southern hospitality to retirees. The Palmetto State exempts Social Security benefits from state income taxes, and it allows residents who are 65 and older to deduct up to $15,000 per person ($30,000 per couple) of retirement income, regardless of the source.

6. Alabama. Alabama is a tax haven for retirees. Social Security benefits, as well as military, public and private pensions, are excluded from state income taxes (but IRAs and distributions from 401(k)s and similar defined-contribution retirement plans are not exempt). Remaining income is taxed as high as 5%, the maximum rate that kicks in when taxable income tops $3,000. Alabama also has some of the lowest property taxes in the U.S. Homeowners 65 and older are exempt from state property taxes, but some cities assess their own property taxes.

5. Georgia. Georgia is doing its part to attract retirees to the Peach State with a sizable exemption for income taxes on retirement income. Taxpayers ages 62 to 64 can exclude up to $35,000 per person from state income taxes for a total of $70,000 per couple. Georgia residents who are 65 and older can exclude up to $65,000 of retirement income (or $130,000 per couple) from state income taxes in 2012. Retirement income is broadly defined as interest, dividends, capital gains, net income from rental property, pensions, annuities and up to $4,000 of earned income.

4. Mississippi. Mississippi turns on its Southern charm for retirees. It not only exempts Social Security benefits from state income taxes, but it is one of only two states that excludes all qualified retirement income — including pensions, annuities, IRAs and 401(k) distributions — from state income taxes.

3. Wyoming. Thanks to the abundant revenues Wyoming collects from oil and mineral companies, residents of the Equality State don’t have to fork over much of their income to taxes. There is no state income tax, so you’ll pay nothing on your Social Security benefits, pension or IRA distributions. The state sales tax is 4%, and counties can add up to 2% in additional levies.

2. Nevada. Nevada is a good bet for retirees because it shifts much of its tax burden to out-of-state tourists and gamblers. The Silver State has no income tax, so your Social Security benefits, pension, IRA distributions and even income from a part-time job won’t be taxed. Property taxes, which are assessed on 35% of a home’s appraised value, are reasonable and typically run about $1,050 per year for a $100,000 house. But sales taxes, which can top 8% in some areas, are higher than average.

1. Alaska. Alaska is a true tax haven for retirees — if you don’t mind the cold weather and you enjoy rugged outdoor beauty. In addition to enjoying no state income tax, Alaska residents benefit from the cold, hard cash of an annual dividend ($1,174 for 2011) from the state’s oil reserves that is distributed to every permanent resident who has lived there for at least one year. There is no statewide sales tax. But some localities impose a sales tax, at an average of less than 2%.

So there you have it. If you’re a hardy soul and don’t mind cold weather, Wyoming or Alaska could the place for you. And if warmer weather is more to your liking, plan a tour of the Old South and check out what those states have to offer. Wherever you plan to live when you retire, be sure to take into account how state taxes can affect your retirement.

Click here to learn more about the top ten tax-friendly states for retirees.

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