The accountant’s guide to state taxes on retirement income

Navigating state taxes on retirement income is a critical aspect of financial planning for retirees. While federal tax rules apply uniformly across the country, state tax rules can vary widely.

As an accountant, understanding state tax considerations for various sources of retirement income — including pensions, Social Security benefits, 401(k) and IRA distributions, Thrift Savings Plans (TSPs), and military retirement income — is crucial in helping your clients minimize their tax liability and make the most of their golden years.

In this post, we’ll explore some hot topics on state-specific retirement income taxes, including 401(k) withdrawals, states that do not tax retirement income, states that exempt military retirement income, and the best tax-friendly states for retirees.

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State tax on retirement income 

State taxes on retirement income vary widely across the U.S. While some states fully exempt retirement income from taxation, others impose different degrees of taxation on distributions from pensions, IRAs, 401(k) plans, military retirement income, and Social Security benefits.

In addition to state income taxes, retirees should consider other state-level taxes, such as property taxes, sales taxes, and estate taxes, which can further impact their overall tax liability. These taxes can affect retirees’ overall financial well-being, particularly if they rely heavily on retirement savings for income.

Perhaps most importantly, choosing a tax-friendly state for retirement can provide significant financial benefits, allowing retirees to maximize their income and enjoy a more comfortable lifestyle. However, it’s essential to carefully evaluate the tax implications of retirement income in each state and consider other factors like cost of living, climate, healthcare, and quality of life when deciding where to retire.

State tax on 401(K) withdrawal

State tax on 401(k) withdrawals refers to the income tax imposed by states on distributions taken from a 401(k) retirement account. Individuals withdrawing funds from their 401(k) plans may be subject to state income taxes depending on where they reside.

Some states do not have income tax, while others make exemptions for retirement income. Most states do not tax Social Security benefits; a few tax 401(k) plans and IRA distributions but not pensions. With so many nuances, it’s important for retirees and individuals planning for retirement to understand how their state handles taxes on 401(k) withdrawals, as this can significantly impact their overall tax liability in retirement.

Which states do not tax retirement income?

Let’s take a detailed look at state tax considerations for various sources of retirement income, including pensions, Social Security benefits, 401(k) and IRA distributions, Thrift Savings Plans, and military retirement income.

• States with no income tax. Eight states do not impose a personal income tax, meaning retirement income from any source remains untaxed. These states include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. Additionally, New Hampshire only imposes income tax on interest and dividend income exceeding $2,400, with plans to phase out this tax by 2025.
• States with no tax on Social Security. In addition to the eight states above, plus New Hampshire, 39 states do not levy income tax on Social Security benefits. These states include Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Vermont, Virginia, and Wisconsin.
• States with no tax on pensions. While most states tax at least a portion of pension income, 17 states — including those without an income tax — do not impose taxes on pensions. These states are Alabama, Alaska, Florida, Hawaii, Illinois, Iowa, Mississippi, Nevada, New Hampshire, Pennsylvania, Rhode Island, South Dakota, Tennessee, Texas, Vermont, Washington, and Wyoming.
• States with no tax on TSPs. Retirement distributions from Thrift Savings Plans are not taxed in 12 states – which include those without an income tax (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming) plus Illinois, Mississippi, New Hampshire, and Pennsylvania.
• States with no tax on estate or inheritance. Lastly, 38 states do not impose estate or inheritance taxes, including Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia, Wisconsin, and Wyoming.

States that don’t tax military retirement income

Military retirement income is not subject to taxation in 33 states, including Alabama, Alaska, Arkansas, Connecticut, Florida, Hawaii, Illinois, Iowa, Kansas, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Nevada, New Hampshire, New Jersey, New York, North Dakota, Ohio, Pennsylvania, Rhode Island, South Dakota, Tennessee, Texas, Utah, Vermont, Washington, West Virginia, and Wisconsin.

Best tax states for retirees

Choosing the right state for retirement can substantially impact your tax burden and overall financial situation. Here are the top five tax-friendly states for retirees, along with a brief overview of the tax pros and cons of each:

1. Florida. Florida is renowned for its lack of state income tax, making it an attractive destination for retirees. However, property taxes can be high in some areas.
2. Nevada. Like Florida, Nevada does not impose state income taxes, offering retirees significant tax savings. The state also boasts a vibrant entertainment scene and a relatively low cost of living. However, sales taxes here can be higher than in other states.
3. Texas. Texas is another state with no state income tax, making it appealing for retirees seeking tax-friendly destinations. Additionally, it has a strong economy and a variety of cultural and recreational opportunities. Property taxes, however, can be relatively high in some areas.
4. Wyoming. Wyoming’s lack of state income tax and low overall tax burden make it an attractive option for retirees. The state also offers abundant natural beauty and outdoor recreational opportunities. However, its rural nature may not appeal to retirees seeking urban amenities.
5. South Dakota. South Dakota is known for its favorable tax climate, including no state income tax and low overall taxes. The state also boasts a low cost of living and a high quality of life. However, the climate may not suit retirees looking for warmer weather.

Understanding state taxes on retirement income is essential for retirees looking to maximize their financial resources and enjoy their golden years. By choosing a tax-friendly state and strategically planning withdrawals from retirement accounts, accountants can help those clients reaching retirement age to minimize their tax burden and prepare for a comfortable retirement lifestyle.

Blog For accountants, it is important to remind clients that early distributions from qualified retirement plans or other tax-favored accounts may incur penalties and trigger the need to file Form 5329.

How to stay up to date on state taxes on retirement income

For accountants, keeping abreast of state taxes on retirement income is crucial as you guide your clients into retirement. With Checkpoint Edge, our innovative tax research tool, you’ll get all the latest tax updates, commentary, and insights to help you stay one step ahead for state-by-state tax considerations.

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