Choosing where to retire — or where not to retire — can be as complicated and individualized a process as preretirement income continuation planning. From a tax perspective, however, there are some states that simply miss the mark when it comes to providing retirees with incentives that are available elsewhere.
Importantly, many states impose a state income tax on Social Security and traditional retirement benefits that can substantially increase a retiree’s overall tax liability (when federal taxation is also considered). Several other states impose state estate or inheritance taxes with exemption levels that are significantly below the federal mark, so that additional (and potentially expensive) planning may be required to reduce the size of the taxable estate. Seniors who anticipate owning valuable property should pay particular attention to the property tax rates imposed by the state (and particular locality) in which they intend to retire—noting that in many states, there are few exemptions for retirees. This article explores the tax treatment of retirees in ten of the least tax-friendly states for retirees.
Vermont may be an ideal retirement location for active retirees looking to take advantage of skiing and the beautiful scenery in the area, but retirees should note that Vermont is one of the few states in the nation that does not provide a state income tax exemption for Social Security benefits. In fact, Vermont’s income tax, which ranges from 3.55–8.95 percent, is imposed on all types of traditional retirement income except for Railroad Retirement benefits. Even out-of-state pension payments are fully taxed. Similarly, Vermont fails to grant property tax exemptions for senior citizens, though lower-income Vermont residents can qualify for a partial rebate of their school and municipal taxes (generally, this rebate is phased out if income exceeds about $100,000). Vermont does impose an estate tax, and the exemption ($2.75 million) is much lower than the federal exemption — with no portability between spouses. The state sales tax, which does not apply to either prescription or non-prescription drugs, is relatively average at 6 percent.
Rhode Island might have once topped the list of the worst states for retirees, but the state has been moving to modify its state tax system to become more tax-friendly. Currently, Social Security benefits are fully taxed at a state income rate that ranges from 3.75–5.99 percent (the top rate has recently been reduced from nearly 10 percent). However, legislation was introduced early in 2015 and, if passed, will eventually eliminate the state income tax on Social Security benefits — so taxpayers should be on the lookout for change if Rhode Island is an appealing retirement destination. Similarly, Rhode Island recently increased its estate tax exemption from around $900,000 to $1.5 million beginning in 2015 — still well below the federal mark, though Rhode Island state estate taxes are much lower, and top out at about 16 percent for the largest estates. Property taxes, though imposed by the city or town, rather than the state, are among the highest in the nation — and the state property tax credit for retirees aged 65 and older isn’t particularly valuable, since it tops out at around $300 for retirees with income of $30,000 or less. State sales tax is set at 7 percent, though, like many states, prescription and non-prescription drugs are exempt.
For many retirees, the Minnesota weather would be daunting enough — but its state tax system creates an even more unfriendly chill for retirees looking for tax breaks. State income tax applies to Social Security benefits in the same manner as federal income tax, though Railroad Retirement benefits are exempt. Out-of-state pensions received while living in Minnesota are similarly subject to the state income tax, which ranges from 5.35–9.85 percent. Minnesota imposes an estate tax, but is currently phasing in a new higher exemption rate — the exemption is $1.4 million in 2015, and will increase by $200,000 each year until it reaches $2 million in 2018. Minnesota offers a property tax deferral program to retirees aged 65 and older with household income of $60,000 or less. This is not an exemption or credit, however — it is characterized as a low interest loan to defer property taxes, and retirees who participate in the program should note that a lien will attach to their property. State sales tax is 6.875 percent, with exemptions for prescription and non-prescription drugs.
Oregon’s relatively high state income tax rate (5–9.9 percent) is not imposed on Social Security or Railroad Retirement benefits, but most other traditional retirement income is taxed at the state level. Retirees receiving a federal pension may be entitled to exclude a portion of that income, depending upon age and income level. The state also imposes an estate tax, with an exemption of $1 million. Oregon has established a property tax deferral system that is similar to Minnesota’s, except the income threshold is set much lower, at around $40,000, though a partial deferral may be available if income exceeds that threshold. Any deferred property taxes, however, are due when the taxpayer dies, sells the property or ceases to permanently live on the property — which can create an additional tax burden in the unfortunate event that the taxpayer eventually requires permanent nursing home care. Oregon does grant taxpayers a sales tax break, however — there is no sales tax in Oregon.
Montana’s state tax (ranging from 1–6.9 percent) applies to most retirement income sources (except Railroad Retirement benefits), including Social Security and pension income. For lower income retirees, Montana allows a $3,600 per-individual exemption for certain pension and annuity income. Taxpayers aged 65 and older can also exempt up to $1,600 of interest income that was reported on a federal return. Montana’s property tax (both state and local) applies to both real and personal property, though residential property owners can receive a 34 percent exemption. Further, homeowners or renters age 62 and older can apply for a property tax credit once they have lived in Montana for 9 months and occupied a residence for 6 months, if gross household income is less than $45,000. Luckily, Montana does not impose an estate, inheritance or sales tax.
Nebraska state income tax (which ranges from 2.46–6.84 percent) applies to Social Security benefits and out-of-state pension benefits to the same extent as the federal income tax applies, exempting only Railroad Retirement Benefits. Nebraska imposes a relatively complex inheritance tax, which exempts a surviving spouse from any tax, but grants only a $40,000 exemption to certain close relatives (such as parents, grandparents, siblings, children and grandchildren). More distant relatives (aunts, uncles, nieces and nephews, for example) are only given a $15,000 exemption, and any heir who does not fall into a specified category has an exemption of $10,000. The rate is 18 percent. Nebraska grants a property tax homestead exemption to residents aged 65 or older who reside in a home with a maximum value of $95,000, if income falls below a certain threshold (generally around $47,000). The maximum value of the exemption is the taxable value of the homestead up to $40,000. Nebraska state sales tax is only 5.5 percent, but local sales taxes can add an additional 2 percent to that rate.
For wealthier retirees, California might creep higher on the list of places to avoid retiring as its income tax ranges from 1–13.3 percent — among the lowest and highest in the nation, depending on income level. Social Security and Railroad Retirement benefits, however, are exempt — though all pensions and other forms of traditional retirement income are taxable. California does not impose an estate or inheritance tax, but property taxes can be very high depending upon the locale. The property tax relief that was previously available for taxpayers aged 62 and older has been suspended, but the first $7,000 of the home’s value is exempt. The statewide sales tax is 7.5 percent, but can be substantially higher if additional local taxes apply.
New Jersey state income tax (ranging from 1.4–8.97 percent) applies to most sources of traditional retirement income, though Social Security and Railroad Retirement benefits are exempt. However, New Jersey permits taxpayers aged 62 and older with income of $100,00 or less to exclude up to $20,000 (for married taxpayers, the amount is reduced to $15,000 for single filers) of income received from pensions, annuities and IRAs. Unfortunately, New Jersey is one of the few states in the nation to impose both an estate and an inheritance tax. The estate tax exemption is $675,000. Application of the inheritance tax depends upon the heir’s relationship to the decedent — for example, spouses, domestic partners and children are exempt from the inheritance tax, while other close relatives, such as brothers and sisters, are taxed on the value of property that exceeds $25,000. If the heir does not fall within one of the enumerated categories, there is no exemption and any property transferred is subject to tax. New Jersey property taxes can be extremely high, depending upon the location, but New Jersey grants a property tax reimbursement to residents aged 65 and older who have income that does not exceed around $70,000 (the amount is adjusted annually). However, to receive the reimbursement, the taxpayer must have resided in New Jersey for 10 years and must have owned his or her home for at least 3 years. New Jersey state sales tax is set at 7 percent.
Connecticut’s state income tax system exempts Social Security benefits for taxpayers with federal adjusted gross income of less than $50,000 (single filers) or $60,000 (joint filers). Most other traditional retirement income is subject to state income tax, at a rate that ranges from 3–6.7 percent. Connecticut also imposes an estate tax, with an exemption set at $2 million, with rates ranging from 7.2–12 percent. Property taxes in Connecticut can be very high, depending on the locality, though they are assessed only on 70 percent of the home’s fair market value, and exemptions apply for certain low income residents aged 65 and older. The state sales tax is 6.35 percent, and increases to 7 percent for certain luxury items, with an exemption for prescription and non-prescription drugs.
New York is another state where its relative ranking from a tax perspective depends heavily upon the locality chosen. New York state income tax rates range from 4 percent to 8.82 percent, though city and local taxes can add to the overall tax burden. However, New York exempts Social Security and local pensions from state income tax, and grants a $20,000 exemption for private pension income if the taxpayer is 59 ½ or older. New York imposes an estate tax with a $1 million exemption. Property taxes for retirees can vary dramatically depending upon the locale — the state gives local governments the option of reducing property taxes for certain lower-income retirees aged 65 and older by only assessing 50 percent of the property’s value in determining the tax. State sales tax in New York is relatively low, at only 4 percent, but local taxes can apply to substantially increase the tax burden. When it comes to New York, its attractiveness as a retirement destination can vary considerably.
Where not to retire, from a tax perspective, depends much more heavily upon the taxpayer’s financial position, chosen locality and dependence upon Social Security than anything else. For taxpayers who are less worried about whether their Social Security benefits are subject to an additional layer of tax, some of the states listed above can actually prove quite attractive. However, when it comes to the overall tax burden faced by retirees, the states that made this list will generally be ones to avoid postretirement.
Robert Bloink and William H. Byrnes are the authors of 2015 Tax Facts on Individuals and Small Business, which focuses exclusively on what individuals and small businesses need to know to maximize opportunities under today’s often-complex tax rules. It is the essential tax reference for financial planners and insurance professionals.