Advice: Taxes

Surprising Tax Havens

State tax laws discriminate based on age, and that can be a good thing for some taxpayers. Even notoriously high tax states can be tax havens for retirees. In fact, Florida and other retiree magnets might not be the tax havens they are promoted as when the full tax picture is considered. Florida has no income tax, but it does have high sales and property taxes (at least for some property owners), and its high homeowner's insurance premiums can be considered a tax for living in the Sunshine State.

Forbes magazine recently published a survey of some surprising retiree tax havens. The details of the tax laws in many states can be eye-opening.

Michigan, for example, exempts $81,840 of private retirement income per married couple plus Social Security benefits from its income tax. That makes the state an overlooked tax haven for retirees.

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Illinois, Mississippi, and Pennsylvania exempt 100% of private and public retirement income (including IRA distributions). These states impose neither a ceiling nor a minimum age on their exemptions. Alabama and Hawaii have unlimited exemptions for payouts from traditional pension plans but do not provide any exemption for IRA distributions.

Only 15 states tax Social Security benefits to some extent; the rest exempt it.

A number of states allow retirees exemptions for income up to a specific amount. Colorado taxes Social Security but exempts the first $48,000 of income for those 65 and older and $40,000 for those 55 to 64. Georgia exempts the first $60,000 of income, including investment income, for those 62 and older.

Because of these exemptions and other details, it pays to look at the details of a state's tax law before concluding whether or not it is a retiree tax haven. New Hampshire has no sales tax and is commonly regarded as a tax haven. But it takes investment income and its real estate taxes are sky high. Tennessee does not have a broad income tax but taxes investment income. That means in many cases its retirees will pay higher state taxes than those drawing pay checks.

If you are considering a move in retirement or want to know the full cost of the retirement location you chose, examine these five key factors.

Social Security is your base retirement income. Determine if your state is one of the few that still taxes all or part of the benefits. Seven states piggyback on the federal tax code and tax up to 85% of benefits. Eight states tax lesser amounts. The others exempt the benefits.

Pension and retirement account income might be exempt in full or in part. As we discussed a few states fully exempt retirement income. Many have a partial exemption, but you have to read the details. It is common for a state to exempt only traditional defined benefit pension payouts, not IRA and 401(k) distributions. Some give government pensions a bigger break than private pensions. A minority of states gives IRA distributions or other nontraditional retirement savings breaks similar to those for other pensions.

Note that if you move in retirement your old state of residence no longer can try to tax your pension or IRA distributions in retirement. But nonqualified deferred compensation might be reachable by the old state.

Take a look at how other income is taxed and at any miscellaneous tax breaks. Some states give seniors special exemptions for investment income or allow deductions for various expenses, including contributions to 529 plans for the grandkids. Others effectively impose penalties on retirees, for example by taxing capital gains and investment income at higher rates than other income.

Real estate and sales taxes can be significant expenses. Some states and localities reduce or defer property taxes for seniors. Others finance most of their government spending through these taxes, and they are high. In some states, taxes on a home can jump significantly for a new owner.

Estate and inheritance taxes are a factor in only 23 states now. The taxes can be higher than federal counterparts in many of these states, so study the effects carefully before moving.

For details on the tax law in a state, take a look at www.RetirementLiving.com. Don't forget to look at county and city taxes before deciding.

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