Greetings again gentle reader, our topic today is what states do not tax your retirement income. This by no means indicates you should move to a tax favored state in your retirement years but it could help. Most people will usually live near family members just to support one another. That support could be babysitting services wherein the retired family members (grandma and grandpa) can help out by taking care of the younger grandchildren while mom and dad are at work full time. I’ve been told that this can be quite a grind for a senior person but also its supposed to “keep you young.” The other part of support is the grandparents’ health may not be so great and they may need help with simple day to day things like bringing in groceries or shoveling snow or just getting around. Not to get too far afield of our most important subject of this article. Were you to be concerned about how your state impacts your retirement cash flow regardless of family then this information is for you.
States can be very different in how they tax retirement income or even other things retirees need like sales tax on medicine or food(Vermont 6%-ouch!), so where you live is an important choice in planning for retirement. Some states don’t have any income tax on ANY income while others have some fairly complex rules. In this case we are referring to IRA and 401(k) distributions, pension payouts and even social security payments. Income taxes are a part of the story, because some states with low- or no-income taxes compensate but having higher property, sales and other taxes. Everything is a trade-off.
Why is this complex? There are states have no income tax at all, some don’t tax retirement income, some tax only a little of your retirement income, and some tax all income. There are even states that tax your retirement based on how much income you make in total.
Here’s the 8 states that have ZERO income tax on any income:
- Alaska–no sales tax
- Florida– 6% sales tax
- Nevada-sales tax 6.85%
- South Dakota– sales tax 4.5%– good
- Tennessee–7% -9.75% sales tax–ouch!
- Texas-6.25% average sales tax
- Washington- 8.25-10.75%– painful sales tax
- Wyoming– 4% sales tax-not bad
Also New Hampshire can be included in this, but NH does tax dividends and interest as ordinary income at 5% which is technically not retirement income but held outside of retirement accounts. The good news on this tax is it is due to be phased out by 2027 so just hold off if you can. Property tax in NH is higher than the national average though but get this–NO sales tax. Only 5 states have no sales tax and they are NH, Montana, Oregon, Delaware and Alaska. Runner up is Colorado at 2.9%. One hidden benefit if you pay a tax preparer, you can get a break on that cost as you wouldn’t be paying them for a state return.
The next group are the states that tax wages and salaries and other earned and unearned income like rental income, dividends and interest but NOT retirement income. Those are Illinois, Mississippi and Pennsylvania. Social Security, pensions and retirement accounts are not taxed. Illinois has a 6.25% sales tax, Mississippi is 7 even and Pennsylvania charges 6%.
Then there are states with different parameters. Georgia does not tax Social Security income and will allow a $65,000 deduction per person on the other types of retirement income. Per person is important especially if you and your spouse have 401k distributions or pensions, then you both get the deduction.
Also, in Pennsylvania all Social Security benefits and IRA and 401(k) income is exempt. In addition to that they do not levy income tax on pension payments for those over 60. Clearly, state taxation of retirement income is somewhat complicated. One of the biggest differences between states is the variety of income caps to qualify for exemptions.
If we could parse this out a little – here are the states that have a FULL exclusion of Social Security payments:
- District of Columbia
- Alabama
- Arizona
- Arkansas
- California
- Delaware
- Georgia
- Hawaii
- Idaho
- Illinois
- Indiana
- Louisiana
- Maine
- Maryland
- Massachusetts
- Missouri
- Mississippi
- New Jersey
- New York
- North Carolina
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- South Carolina
- Virginia
- West Virginia
The remaining 15 states with broad-based income taxes tax Social Security to some extent:
- Minnesota, Nebraska, North Dakota, Rhode Island and Vermont tax Social Security income to the extent it is taxed by the federal government.
- Connecticut, Iowa, Kansas, Missouri, Montana and Wisconsin tax Social Security income above amounts of total income. Iowa will phase out its Social Security tax levy from 2007 through 2014. Missouri will phase out its Social Security tax levy by 2010, although the tax will continue above certain income levels (see notes to table).
- Colorado, Kentucky, New Mexico and Utah require that federally untaxed Social Security benefits be added back to federal AGI to calculate the base against which their broad age-determined income exclusions apply.
10 States that exclude pension income
Ten states exclude all federal, state and local pension income from taxation – Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania. Among these 10 states, only Kansas taxes any Social Security income; in 2007 Kansas provided that by tax year 2008 persons with an AGI of less than $75,000 may exclude Social Security income from state taxation.
These 10 states differ on the taxation of retirement income from private-sector sources. Kansas and Massachusetts do not exclude any private-sector retirement income, but most of the others allow a fairly broad exclusion:
Pennsylvania allows a full exclusion.
Alabama excludes income from defined benefit plans.
Hawaii excludes income from contributory plans.
Illinois and Mississippi exclude income from qualified retirement plans.
Louisiana, Michigan and New York cap the private-sector exclusion at $6,000, $42,240 and $20,000, respectively (amounts are for taxpayers filing singly).
If you are thinking about relocating in retirement, please use a financial or tax advisor or your own research if you have enough confidence in it, to learn about the potential tax issues this may cause you. Please use this article as a guideline rather than fact. And so gentle reader I say so long may you live your best life.
Jeff Dragon 
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