The Impact of Relocating in Retirement: Understanding State Tax Laws and Residency

As you approach retirement, you may be dreaming of relocating to a new state—perhaps one with a warmer climate, closer to family, or with a lower cost of living. However, before making a move, it's crucial to understand how state tax laws could affect your financial situation in retirement. Taxes vary widely from state to state, and relocating without careful planning could cost you more than you expect.

In this blog, we’ll explore the impact of relocating during retirement, with a focus on how state tax laws can affect your income, estate, property, and overall financial picture. By the end, you’ll have a clearer idea of what to consider before making a move and how to plan strategically to minimize taxes in your golden years.

Why State Taxes Matter in Retirement

Your state of residence plays a significant role in determining how much of your retirement income gets taxed. This is particularly important when you consider that many retirees live on fixed incomes, relying on Social Security, pensions, and savings.

The most significant taxes that retirees typically face include:

1. State Income Taxes
2. Taxes on Social Security Benefits
3. Taxes on Retirement Income (e.g., pensions, IRAs, 401(k)s)
4. Property Taxes
5. Estate and Inheritance Taxes

Choosing a state with favorable tax laws for retirees can make a substantial difference in how much money you have available to cover living expenses, healthcare, and leisure.

1. State Income Taxes: A Key Factor in Retirement Relocation

Not all states impose income taxes, and this can be a key factor when considering where to retire. States like Florida, Texas, Nevada, and Washington are known for having no state income tax, making them attractive for retirees looking to stretch their income further.

However, while states without income taxes can seem like a tax paradise, it’s important to consider the bigger picture. Some states with no income taxes may have higher property or sales taxes to make up for lost revenue. Additionally, some states impose taxes on certain types of retirement income, such as pensions or distributions from traditional IRAs and 401(k)s.

States With No Income Tax:

• Florida
• Texas
• Nevada
• Washington
• South Dakota
• Wyoming
• Alaska

States With Low or No Taxes on Retirement Income:

• Mississippi
• Illinois
• Pennsylvania
• Hawaii

Why It Matters: If you're planning to rely on income from pensions, IRAs, or 401(k)s, moving to a state with no or low taxes on retirement income could lead to significant savings.

What to Consider:

• If you expect to rely heavily on tax-deferred accounts like IRAs or 401(k)s, research states that don’t tax distributions from these accounts.
• Consider your total tax liability—some states may offer favorable income tax rates but could have high taxes in other areas.

2. Social Security Taxes: Federal and State Considerations

While Social Security benefits are taxed at the federal level, they are not taxed by most states. However, 12 states do tax Social Security income, which can come as a surprise to many retirees.

The 12 states that currently tax Social Security benefits include:

• Colorado
• Connecticut
• Kansas
• Minnesota
• Missouri
• Montana
• Nebraska
• New Mexico
• Rhode Island
• Utah
• Vermont
• West Virginia

Why It Matters: If you live in a state that taxes Social Security, this can reduce the amount of income you have to live on, especially if you rely heavily on Social Security benefits for retirement.

What to Consider:

• If Social Security is a significant part of your retirement income, research states that don’t tax Social Security to maximize your benefits.
• If you plan to move to one of the 12 states that tax Social Security, look into exemptions or income thresholds that may minimize your tax burden.

3. Taxes on Retirement Income: Pensions, IRAs, and 401(k)s

State taxation of retirement income varies widely. Some states tax distributions from pensions, IRAs, and 401(k)s as ordinary income, while others offer full or partial exemptions.

For example:

• Illinois, Mississippi, and Pennsylvania fully exempt income from pensions and retirement savings plans from state taxes.
• Hawaii offers exemptions on some types of retirement income but taxes others.

Why It Matters: Pensions, IRAs, and 401(k)s are often a major source of income for retirees. The tax treatment of these distributions can make a substantial difference in your after-tax income.

What to Consider:

• Research how your state of choice taxes different types of retirement income.
• If you receive a pension, find out whether the state offers exemptions or preferential tax treatment for public or private pensions.
• For those drawing income from tax-deferred accounts, check if distributions are taxed at the state level and how this might affect your retirement income.

4. Property Taxes: Balancing Low Income Taxes With High Property Taxes

While state income taxes often get the most attention, property taxes are another important consideration, particularly if you plan to own a home in retirement. Some states with low or no income taxes, such as Texas, may have higher property taxes to generate revenue. This can be a disadvantage if you're planning to downsize or purchase property in retirement.

Why It Matters: Property taxes are typically a fixed, annual expense and can be a significant financial burden for retirees, especially if you own a larger or more valuable home.

What to Consider:

• Research the property tax rates in the state and community you're considering.
• Look into whether the state offers property tax exemptions or deferrals for retirees or seniors. Some states offer tax breaks based on age or income, which can reduce the burden.
• Factor in local property tax rates, as they can vary widely even within the same state.

5. Estate and Inheritance Taxes: Protecting Your Legacy

Estate and inheritance taxes are another consideration when relocating in retirement, especially if you plan to pass on significant assets to your heirs. While the federal estate tax only applies to estates valued at over $12.92 million (as of 2023), some states impose their own estate or inheritance taxes, and the thresholds can be much lower.

States With Estate Taxes:

• Connecticut
• Illinois
• Maine
• Massachusetts
• Minnesota
• New York
• Oregon
• Rhode Island
• Vermont
• Washington
• Washington, D.C.

States With Inheritance Taxes:

• Iowa
• Kentucky
• Maryland
• Nebraska
• New Jersey
• Pennsylvania

Why It Matters: If you plan to leave a significant estate or pass on assets to heirs, understanding estate and inheritance taxes in your state is crucial for minimizing the tax burden on your beneficiaries.

What to Consider:

• If estate planning is a priority, consider moving to a state with no estate or inheritance taxes to preserve more of your wealth for your heirs.
• Even if your estate is below the federal threshold, some states have much lower exemptions, meaning that your heirs could face state estate taxes.
• Work with a financial advisor or estate planning attorney to develop tax-efficient strategies for passing on assets.

6. Other Tax Considerations: Sales Taxes and Cost of Living

In addition to income, property, and estate taxes, sales taxes and the overall cost of living can also play a role in determining the best place to retire. Some states with no income tax may have higher sales taxes or a higher cost of living, which can erode your savings over time.

States With High Sales Taxes:

• California
• Tennessee
• Arkansas
• Louisiana

Why It Matters: Even if you’re not paying state income taxes, a high cost of living or high sales taxes can significantly impact your spending power.

What to Consider:

• Take a holistic view of your potential expenses in retirement. Factor in all taxes—income, sales, property—as well as the general cost of living in the area.
• Make sure the total tax burden in your new state aligns with your retirement income and lifestyle goals.

Steps to Take Before Relocating in Retirement

Relocating in retirement is a major decision that requires careful financial planning. Here are some steps to take before making the move:

1. Research State Tax Laws: Understand how your retirement income, Social Security benefits, and other sources of income will be taxed in the state you plan to move to. Look beyond income taxes and consider property, sales, and estate taxes.
2. Consult a Financial Advisor: A financial advisor can help you run the numbers and understand the tax implications of relocating. They can also help you develop strategies to minimize taxes and protect your retirement income.
3. Consider the Bigger Picture: Taxes are important, but don’t forget to consider other factors such as proximity to family, healthcare access, climate, and overall quality of life. Sometimes, a state with slightly higher taxes may offer other benefits that make it a better fit for your retirement.
4. Plan for Residency Changes: If you’re moving from a state with higher taxes to one with lower taxes, make sure to establish residency properly. This typically involves spending a certain amount of time in the new state, registering to vote, getting a new driver’s license, and moving your financial accounts.