Based on the state in which you retire, state income taxes could vary by thousands of dollars. However, as a recent Kiplinger article, “State Taxes on Retirees Differ by Types of Retirement Income,” tells us, it’s not just a state’s tax rate that matters. The type of income you get in retirement frequently has a bigger impact on your state taxes than your tax rate, because each state has its own method of taxing specific types of retirement income.
Let’s look at the taxes on Social Security benefits in retirement. The federal government can tax up to 85% of Social Security benefits, but most states don’t tax Social Security benefits. There are seven states—Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming—that don’t tax Social Security benefits because they don’t have any income tax. New Hampshire and Tennessee only tax interest and dividends. Social Security benefits are exempt from tax in DC and 28 states: Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia, and Wisconsin.
That leaves 13 states where part of Social Security benefits may be taxable in retirement. New Mexico, Utah, and West Virginia currently tax Social Security benefits to the same extent they are taxed on federal returns, but West Virginia plans to phase out its tax on Social Security benefits in 2020. Taxation of Social Security benefits in the rest of the states—Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, North Dakota, Rhode Island, and Vermont—is based on your income and, in many instances, on your filing status. Some of these states may also exempt Social Security for taxpayers under certain income thresholds.
As far as retirement plan payouts, state taxation of payouts from retirement plans, such as pensions, IRAs, and 401(k)s, can be more complicated. States without an income tax or that just tax interest and dividends don’t tax retirement plan payouts. However, with the other states, it’s all over the board. Mississippi and Pennsylvania are the most generous—they typically don’t tax any retirement income. However, California, D.C., Nebraska, and Vermont offer few or no tax breaks for retirement plan payouts. In some cases, the type of retirement plan involved makes a difference.
Reference: Kiplinger (October 28, 2019) “State Taxes on Retirees Differ by Types of Retirement Income”