The financial climate is more pleasant in some states than in others.
Maybe you’re thinking about relocating in retirement, in hopes of enjoying milder weather and lower expenses. Before you make a move, it pays to assess the overall tax burden of your future home. Some states that are currently tax-friendly could get a lot less chummy as they scramble to find new sources of revenue to plug gaping holes in recession-shredded budgets.
No matter where you live, your federal taxes will be about the same. But you’d be amazed at how much your state and local tax burden may vary from one location to another. And if you itemize deductions, how much you pay—and deduct—in local property taxes could affect the bottom line of your federal return, too.
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However, in 2009, if you don’t itemize, you can boost your standard deduction (usually $11,400) by up to $1,000 for property taxes paid on your principal residence, if you are married and file a joint return. Single taxpayers who claim the standard deduction can boost their $5,700 write-off by up to $500. People planning to retire “often use the presence or absence of a state income tax as a litmus test for a retirement destination,” says Tom Wetzel, president of the Retirement Living Information Center (www.retirementliving.com). “But higher sales and property taxes can more than offset the lack of a state income tax.”
Seven states—Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming—have no state income tax. Two states—New Hampshire and Tennessee—tax only dividend and interest income that exceeds certain limits. But many of the remaining 41 states (and the District of Columbia) that impose an income tax offer generous incentives for retirees. If you qualify, moving to one of these retiree-friendly areas could be cheaper than relocating to a state with no income tax.
Plus, in tough economic times, states without a personal income tax have fewer sources of revenue and are more likely to raise property or sales taxes and other fees to shore up their budgets. State tax revenues plunged nearly 12% during the first three months of 2009, the sharpest decline on record, reports the Nelson A. Rockefeller Institute of Government. And it may take states years to make up the shortfall.
Despite the dismal economy, there is one bright spot for retirees on the move: falling home prices. “We see exceptional opportunities in some sought-after retirement destinations,” says Mary Lu Abbott, editor of Where to Retire magazine (www.wheretoretire.com). If you thought locations such as Naples, Fla., Scottsdale, Ariz., and Hilton Head, S.C., were out of your price range, it could be a good time to take a second look. Property taxes, however, have not been moving down as quickly.
Although most states that impose an income tax exempt at least a portion of pension income from taxation, they often treat public and private pensions differently. For instance, ten states—Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania—exclude all federal, military and in-state government pensions from taxation. But Kansas taxes public pensions from all other states. Pennsylvania and Mississippi, by contrast, exempt all retirement income—including distributions from IRAs and 401(k) plans.
Some states have special breaks based on age or income. For instance, New Jersey allows residents 62 and older with incomes of $100,000 or less to exclude up to $20,000 of private-pension income from taxes. New York allows residents 59½ and older to exclude up to $20,000 of private or out-of-state public pensions from taxes, regardless of their total income. In Michigan, individuals can exclude up to $43,440 of private-pension income ($86,880 for married couples) from state taxes in 2009.
Three states are particularly tough on retirees. Not only do they fully tax most pensions and other retirement income, they also have high top tax brackets: California (9.55% on income less than $1 million), Rhode Island (9.9%) and Vermont (9.5%). Connecticut and Nebraska also fully tax retirement income, with top rates of 5% and 6.84%, respectively.
Social Security Benefits
Depending on your income, you may be required to include up to 85% of your Social Security benefits in your taxable income when filing your federal return. But in recent years, many states have been moving away from taxing Social Security benefits.
In addition to the nine states that lack a broad-based individual income tax, 27 states and the District of Columbia do not tax Social Security: Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin.
The remaining 14 states—Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia—tax Social Security benefits to some extent. Missouri will phase out its Social Security tax by 2012, and Iowa will gradually phase out its Social Security tax by 2014. Kansas residents can now exclude Social Security income from their taxes if their adjusted gross income is less than $75,000, regardless of whether they are single or married.
Seniors living in Colorado, New Mexico and Utah must add back the portion of Social Security benefits not taxed by the federal government to calculate their eligibility for certain state tax breaks.
Don’t forget to include state and local sales taxes in your personal budget analysis. Some states exempt food and medicine; others tax every dime you spend. Five states—Alaska, Delaware, Montana, New Hampshire and Oregon—have no state sales tax (although Oregon is considering adding one). At the other extreme, California’s newly increased sales tax of 8.25% is the highest statewide sales tax in the nation. Five other states—Indiana, Mississippi, New Jersey, Rhode Island and Tennessee—each have a state sales tax of 7%.
But the retail-tax pain doesn’t always stop at the state level. Most states allow cities and counties to assess their own sales tax (including Alaska, which has no state sales tax). For example, Chicago imposes a 10.25% combined sales tax, the highest of any major U.S. city. Combined rates can reach 10% in Alabama, Arizona and California. Only three states—Connecticut, Kentucky and Maine—do not allow municipalities to impose their own sales tax on top of state levies.
In 2008, more than 500 U.S. cities either increased their sales-tax rate or initiated a new sales tax, according to the annual sales-tax-rate study by Vertex, in Berwyn, Pa. “We’re already hearing discussions about changes in state taxes to come this year, and we expect the average state sales-tax rate to continue to trend modestly upward for a fourth consecutive year,” says Vertex’s John Minassian.
Property taxes are a major cost factor, particularly for retirees living on fixed incomes. But many local jurisdictions offer property-tax breaks to full-time residents, some based on age alone and others linked to income. Tax rates vary significantly from state to state and among cities in the same state. For example, a retired couple with an annual income of $90,000 and a home worth $525,000 would pay about $11,800 in total state taxes if they lived in the upscale community of Boca Raton on the east coast of Florida; but if they lived in the ritzy enclave of Naples on the state’s Gulf Coast, they’d pay about $4,000 less, according to America’s Best Low-Tax Retirement Towns (Vacation Publications, $18.95).
That book is a good starting point if you’re trying to determine the financial implications of moving or staying put. It rates the total tax burden for more than 200 cities, broken down by different income levels and home values and based on 2006 tax rates.
Based on data from a 2007 Census Bureau survey and Tax Foundation calculations, the five states with the lowest median real estate taxes (from lowest to highest) are Louisiana, Alabama, West Virginia, Mississippi and Arkansas. States with the highest median real estate taxes (from highest to lowest) are New Jersey, New Hampshire, Connecticut, New York and Rhode Island.