Retirement is something that most people can look forward to. You can choose to permanently leave the workforce behind, kick up your feet, and collect the retirement income that you’ve worked so hard to earn. One important thing to remember — you’ll likely continue to pay taxes.
When you’re living on a fixed income, what you pay in taxes can make a big difference. There are different tax rules for each source of income and these rules also depend on where you choose to live. Here’s what you should know about tax-friendly states and which ones won’t tax your retirement income.
States That Do Not Tax Retirement Income
As of 2021, there are nine states with no income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
However, for the 2020 tax year, New Hampshire and Tennessee did tax investment income (not earned income) in the form of interest and dividends at 5% and 1%. If you lived in one of those states during the 2020 tax year and received income from your investments, you will need to file a state tax return.
Keep in mind that states that don’t tax income collect their revenue in other ways. This is usually in the form of property taxes and sales taxes. Texas and New Hampshire have some of the highest property tax rates in the country. Tennessee has the highest state and local sales tax rate at 9.55%, according to the Tax Foundation.
States with Income Tax Breaks
Other states still offer retirees tax breaks on retirement income. Illinois, Mississippi, and Pennsylvania don’t tax distributions from 401(k) plans, IRAs, or pensions and Alabama and Hawaii don't tax pension income but do tax distributions from 401(k) plans and IRAs.
These 24 states exempt or provide a tax credit for a portion of pension income: Alabama, Arkansas, Colorado, Delaware, Georgia, Hawaii, Iowa, Kentucky, Louisiana, Maine, Maryland, Michigan, Missouri, Montana, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, South Carolina, Utah, Virginia, and Wisconsin.
These states don’t tax military retirement income: Alabama, Arkansas, Connecticut, Hawaii, Illinois, Iowa, Kansas, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Missouri, New Jersey, New York, North Dakota, Ohio, Pennsylvania, West Virginia, and Wisconsin.
Least Tax-Favorable States fo Retirees
Some states aren’t as tax-favorable to retirees as others. Tax rates are high with fully taxed pension income, as well as 401(k) and IRA distributions. Here are the least tax-favorable states and their individual top tax rates for 2021 according to the Tax Foundation:
- California: 13.3% for income over $1 million
- Minnesota: 9.85% for income over $164,400
- Vermont: 8.75% for income over $200,200
- Idaho: 6.925% for income over $200,200
- Connecticut: 6.99% for income over $500,000
- Nebraska: 6.84% for income over $31,750
- West Virginia: 6.5% on income over $60,000
- Rhode Island: 5.99% on income over $148,350
- Kansas: 5.7% on income over $30,000
- North Carolina: 5.25% on all income
- Massachusetts: 5% on all income
- Arizona: 4.5% on income over $159,000
- Indiana: 3.23% on all income
- North Dakota: 2.9% on income over $433,200
While taxes aren’t everything, they could be a determining factor in where you choose to retire. Keep in mind that you must report income earned in other states when filing your state tax return. If you plan to retire to a state that does not tax retirement income, it’s important to become familiar with local tax laws.
