State Income Taxes in Retirement
Which states have tax breaks for retirees?
Out of all 41 states with personal income taxes, 37 states have some type of exemption for retirement income. However, each state has a different mix of income tax breaks for retirees. Most states exempt certain types of retirement income, but tax others. Only two states exempt all retire income, so unless you're able to retire in a state with no income tax (which may have high taxes in other areas), you should consider state income taxes before deciding where to retire.
States that Exempt Social Security
The District of Columbia and 27 other states exempt all Social Security benefits from income taxes. Those states are: 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. Iowa will phase out their tax on Social Security between 2007 and 2014.
Taxing Social Security
The remaining states with personal income taxes include Social Security benefits in taxable income to some extent:
- Connecticut, Iowa, Kansas, Missouri, and Montana tax Social Security benefits depending on the income level of the taxpayer. For example, Connecticut taxes a portion of Social Security income for single taxpayers with an adjusted gross income (AGI) of over $50,000 ($60,000 for married filing jointly). Kansas taxes Social Security benefits of taxpayers with AGIs over $75,000.
- Colorado, New Mexico, and Utah only exclude portions of Social Security income depending on the age of the taxpayer. For example, Colorado allows taxpayers aged 55-64 to exclude $20,000 of Social Security and qualified retirement income. Taxpayers 65 and over can exclude $24,000. Anything over the exclusion amounts would be taxed.
- Minnesota, Nebraska, North Dakota, Rhode Island, Vermont, and West Virginia tax Social Security income to the extent it's taxed on the taxpayer’s federal return.
State Tax Exemptions for Military Pensions
Some states exempt military pensions from income taxes entirely. These states are: Alabama, Hawaii, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Mississippi, Missouri, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Tennessee, and Wisconsin.
Many other states allow for some portion of military pension income to be excluded.
State Taxes and Government Pensions
Federal laws dictate that state tax policy cannot discriminate against federal civil service pensions. This means that they cannot have more favorable tax treatment for state and local pensions than they do for federal civil service pensions. They can however create tax policies that discriminate between their own state pensions and other state’s pensions.
Arizona, Idaho, Kansas, Louisiana, New York, Oklahoma, and the District of Columbia provide greater tax relief plans for their state’s pension plans than they do for out-of-state government pension plans.
Only ten states exclude all federal, state, and local pension income from taxation. These include Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania. Missouri will allow for a total exemption for all public pension income by 2012 for taxpayers who meet income limitations. Until 2012, the exemption will be phased in at an increasing percentage each year.
State Taxes and Private Pensions
State income tax exclusions for private pension income are not as generous as those for Social Security and public pensions. In fact, twelve states and the District of Columbia fully tax private pensions. Those states are Arizona, California, Idaho, Indiana, Kansas, Massachusetts, Minnesota, Nebraska, North Dakota, Rhode Island, Vermont, and West Virginia.
On the other hand, Alabama, Hawaii, and Illinois exempt nearly all retirement income. They exempt 100% of Social Security, military pensions, government pensions, and certain types of private pensions. Only Mississippi and Pennsylvania exempt all retirement income, including 401(k) and IRA distributions.
The Unfriendly States for Retirees
Four states: Minnesota, Nebraska, Rhode Island, and Vermont allow no exclusions for pension and other retirement income. California has only a small tax credit for senior citizens and excludes only Social Security benefits and railroad retirement benefits from income taxes.