What Are the Most Tax-Friendly States for Retirement?

What Are the Most Tax-Friendly States for Retirement?

Sun and sand top the list of many retirees' dream destinations, but what about lower taxes? Here are some of the most tax-friendly states you might consider for retirement.

Published by Motley Fool Wealth Management Wed, Dec 14, 2022

read time 5 min read

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Have you started fantasizing about new places where you may want to move in retirement?

Data show that Florida, South Carolina, and Arizona are the top three states where people retire.1 Other top destinations include Delaware, Nevada, Wyoming, Mississippi, and New Mexico. And where are retirees leaving? The top five include Rhode Island, New Jersey, Connecticut, Wyoming, and New York. Interestingly, Maine and Wyoming fall in the top inbound and outbound states for retirees!

Why do retirees shift locales? Some desire a specific climate (I want to live where it’s warm year-round). Others base their decision on favorite activities (I need 10 golf courses within an hour's drive). At the same time, for many, the choice location is close to (or far from!) relatives (I’d like to babysit my grandbabies).

Everyone has a specific reason for their retirement destination. But there’s one important consideration that’s universal—the financial aspect. What are we talking about? Taxes.

But before we get to the good stuff, we want to note that while we can discuss tax considerations for retirees in a general way, Motley Fool Wealth Management does not (and is not permitted to) provide tax or legal advice. Remember, the discussion of tax in this article is intended for educational purposes only and should not be relied upon as personalized tax or financial planning advice. If you need such advice, please always consult your tax and legal professionals before making any decisions.

With that said, let’s dig in!

How expensive is the state where you plan to retire?

Benjamin Franklin famously said, “…in this world, nothing is certain except death and taxes.” How true that is! Everyone, yes, even retired folks, pay taxes. There are two buckets—federal, and state and local.

Federal taxes are levied by the U.S. government at the same rate regardless of where you live. But state and local taxes change depending on location. And, unsurprisingly, the level and type are as varied as there are flavors of ice cream! So, before you decide where to put down your retirement roots, consider how your choice can impact your retirement savings.

Our research on tax-friendly retirement states

To create a holistic picture, we reviewed several different tax types.

First, we examined income tax rates. Income taxes are usually structured based on earnings ranges, so we chose the top marginal rate for this exercise to make a similar comparison.

Then, since many retirees don’t have earned income from a job or business, they rely on money from Social Security or retirement accounts, like a pension, IRA, or 401(k). These sources may incur federal taxes, but some states impose their own. Therefore, we further delineated income by source. For example, does a state collect tax on Social Security, distributions from a 401(k), or dividends from investments?

Second, we considered property and state and local sales taxes. First, we ranked how much the median home costs to buy by looking at the median listed price per square foot. Then we looked at property and sales tax. Of course, there are variations by region or county within each state, so our assessment reflects the average rate. Here’s how we define them:

  • Property: the amount paid as a percentage of owner-occupied housing value as of 2020
  • State and Local Sales: combined state and average local sales tax as of January 2022

Lastly, we thought about other state-imposed taxes. These include a tax on gas, groceries, estate, and inheritance.

Additionally, we looked at charitable gifting tax benefits and age-related deductions as offsets.

Here’s what we found.

What are the best tax states for retirees?

After collecting the tax data, we used a point system to rank the states in each category, giving more points for lower-than-average or no taxes. We then added up the points to arrive at a total point amount. Finally, we ranked the states based on their total points.

States with points of…

  • 16 or greater are the top or best tax states
  • 11-15 are middle of the road
  • 10 or lower are the bottom or worst tax states

RetirementIncomeMap1-1Source: Motley Fool Wealth Management, Nov. 2022. See disclosures for data sources and tax year.

We recognize that this map doesn’t tell the whole story because it combines the various types of taxes and weighs them equally. But in reality, a gas tax does not have the same impact on your wealth as taxes on retirement income or property. So, for now, we’re focusing on retirement income. We summarize some of our findings based on four categories: no income tax, no-retirement income tax, retirement-friendly, and worst-retirement tax states.

The no-income tax states

Seven states do not tax any income—including retirement income. They include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming. Of those, only Wyoming has below-average property, sales, and gas taxes and does not tax estates or inheritance. Four others—Florida, Nevada, South Dakota, and Tennessee—also have below-average property tax, while the last two also have below-average gas tax.

Two other states—New Hampshire and Washington—have no income tax, but they do collect on taxable investment income like dividends and interest. And Washington is one of the few states that tax estates.

The no-retirement income tax states

As retirees, you may be unconcerned about earned income tax since you no longer work. Therefore, states that do not collect on tax-deferred retirement accounts, like 401(k)s, IRAs, and pensions, and Social Security, might be just as desirable. In addition to the states that do not collect on earned income, three other states don’t tax retirement income—Pennsylvania, Mississippi, and Illinois. However, some add a tax on investment income, like capital gains, interest, or dividends.

RetirementIncomeMap2-1Source: Motley Fool Wealth Management, Nov. 2022. See disclosures for data sources and tax year.

The retirement tax-friendly states

The next best grouping has some tax advantages, but not to the extent of the previous two. There are several tiers within this group. For example, Ohio, Oklahoma, and Kentucky have below-median income tax rates, no or partial retirement income tax, and offer age-related deductions.

The next-best states fall below the median income tax rate, do not tax Social Security, and only partially tax retirement income. Colorado, Louisiana, and Michigan land here.

The third tier includes low-income tax rate states that do not tax Social Security but fully tax either a pension or tax-deferred income. They include Arizona, North Dakota, North Carolina, Massachusetts, and Alabama.

Finally, higher-income tax states that do not tax Social Security but partially tax pension or tax-deferred accounts include Delaware, Iowa, Maine, New Jersey, New York, Oregon, South Carolina, Arkansas, Georgia, Maryland, Virginia, West Virginia, and Wisconsin.

The worst retirement tax states

Some states have above-median income tax rates and tax some or partial retirement accounts with no age-related deductions. For example, Connecticut's (CT) income tax rate is above the median at 6.99%, and it collects tax on Social Security. Its property and gas taxes are also above average, and it charges an estate tax. CT also imposes a tax on pensions and tax-deferred accounts but offers some exclusions/reductions. Finally, it does not provide an age-related or charitable deduction. Rhode Island is similarly tax unfriendly.

Other states—Minnesota, Montana, Nebraska, New Mexico, and Vermont—are similar but offer deductions and specific exemptions. Kansas and Missouri are slightly more appealing because their tax rates are near the median.

Calculating state tax on $100K annual retirement income

While the above is helpful information, since most states impose tax rates at different income levels, we calculated how much state tax a retiree would pay on a $100K annual income. Our analysis used the following parameters:

A 65-year-old married (filing jointly) couple whose $100K yearly income comes from:

  • Social Security: $33,000
  • Corporate pension: $33,000
  • Capital gains on taxable investments: $34,000

Here are the results:

StateTax100kCalculations are for a $100K income coming from $33K from Social Security, $33K from a corporate pension fund, and $34K from a taxable brokerage account. Tax rates were calculated from data from: Social Security and corporate pensions from smartasset.com and capital gains tax from fool.com, Oct. 6, 2022. *Long term is defined as an asset held for three years.

Cost of living

Another consideration beyond taxes is the cost of living. We looked at gas and grocery tax, but many other costs may tip you over your budget. So, before you make your decisions, this calculator can help you compare various cities.

Wrapping it Up

Lifestyle probably influences the choice of where to retire. But since many retirees are on a fixed budget, costs often come into play. So let’s see if the top 10 retirement destinations coincide with our ranking of the no-income or no-retirement income tax states.1

Woo-hoo! Four out of the top 10—Florida, Mississippi, Nevada, and Wyoming—are also very retirement-income tax friendly. But then it gets interesting. For example, Illinois and Wyoming fall in the top outbound retirement states despite offering some of the best retirement tax incentives. And regardless of being in the worst tax state category, New Mexico is considered one of the top destinations for retirees.

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12021 National Movers Study, accessed Nov. 17, 2022

Source for maps: For deductions and exemptions, investment income, Social Security, pensions and other retirement income, data was obtained from kitces.com and AARP as of Sept. 2022. For Property Tax, data was obtained from propertyshark.com as of 2020. For state and local sales, gas, grocery, and estate and inheritance tax, data was obtained from Tax Foundation as of Feb. 2022. For charitable benefit, data was obtained from U.S. Charitable Gift Trust as of Feb. 2022. For square footage of listed houses, data was obtained from the U.S. Federal Reserve as of Nov. 2002, except for Washington D.C. which is as of Oct. 2022

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