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.