Tax Free Retirement: States that Don't Tax Retirement Income

Taxes have a way of finding your income no matter where it tries to hide. But what if there were places where you don't have to play hide and seek?

Remember those road trips you promised yourself you'd take once you retired? Well, it's time to pack your bags, but this trip is a little different.

Understanding Retirement Income Tax

With federal taxation, retirement income is subject to a set of considerations that include the nature of the income and your filing status. The IRS does offer certain tax advantages, such as the potential for partially tax-free Social Security benefits, which are contingent on your combined income.

The taxation of retirement income introduces additional complexity at the state level. Each state operates under its own set of regulations, with some providing substantial exemptions and others levying taxes on retirement income in full. Retirement income varies widely across states, making it essential to understand the specific tax implications in each state.

State taxation is diverse. Some states, like Florida and Nevada, offer a reprieve from income tax, allowing retirees to enjoy their pensions, 401(k)s, and IRAs without the burden of state taxes. State income taxes can significantly impact retirees' financial well-being, so understanding these implications is crucial.

Each state’s approach to retirement income taxation is unique, and a thorough evaluation is beneficial when planning for retirement.

But then, some states take a bit more of a hands-on approach. They’ll give Social Security benefits a pass, but they might tap into other retirement funds. And pensions? It’s a toss-up. Some states tax them, others don’t.

But here’s the good news: even in states where your retirement funds might face taxes, there are often perks and breaks for retirees. You might find tax caps, exemptions if your income is below a certain threshold or other sweet deals. Pennsylvania, for example, has a flat personal income tax rate of 3.07 percent, which can be beneficial for retirees.

The catch is, tax laws change quite often, so it’s crucial to stay updated. Rhode Island, for instance, does not tax military retirement income but does tax Social Security income, highlighting the need to understand each state's policies.

Many states exempt all retirement income from taxation, whereas others treat IRA and 401(k) withdrawals, pension disbursements, and Social Security payments as taxable income. Social Security income is treated differently across states, with some offering full exemptions and others imposing taxes based on adjusted gross income or age.

However, income tax isn’t the whole picture, since states with reduced or zero income tax often have elevated property, sales, and miscellaneous taxes.

In this group of eight states, residents enjoy a special perk: they don’t pay a dime in state income tax. Whether it’s your income from your 401(k), IRA, pension payments or Social Security check.

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

What does this mean for you?

Well, if you’re earning a salary, collecting dividends, or cashing in on investments, these states won’t take a cut from your income.

For retirees, this is particularly sweet news. Those Social Security checks, pension payments, and any withdrawals from retirement accounts like 401(k)s or IRAs? They’re all yours, free from state tax.

If you’ve got investments outside of retirement accounts, those earnings are also state tax-free.

Then there’s New Hampshire, which is almost in the same boat. It doesn’t tax your wages or retirement funds, but it does currently tax dividends and interest.

So, if you’ve got some investments that generate these types of income, you’ll want to keep an eye on this, especially since New Hampshire is planning to eliminate these taxes by 2027.

What is considered retirement income?

Retirement income refers to the various sources of income that individuals receive during their retirement years. This can include:

• Pension income: Regular payments received from a defined benefit plan or other pension plan.
• Social Security benefits: Monthly payments received from the Social Security Administration.
• 401(k) and IRA distributions: Withdrawals from individual retirement accounts or employer-sponsored retirement plans.
• Military retirement pay: Payments received from the military for service-related retirement.
• Annuity income: Regular payments received from an annuity contract.
• Dividend and interest income: Income earned from investments, such as stocks, bonds, and mutual funds.

These sources of retirement income are subject to taxation by the federal government and, in some cases, by state governments as well. Understanding the different types of retirement income can help you plan better for your financial future and minimize your tax liability.

How do states tax retirement income?

States tax retirement income in various ways, depending on the type of income and the state’s tax laws. Here are some common methods states use to tax retirement income:

• Exemption: Some states exempt certain types of retirement income, such as Social Security benefits or pension income, from taxation.
• Partial exemption: Some states exempt a portion of retirement income from taxation, such as the first $10,000 of pension income.
• Taxation: Some states tax all retirement income, including Social Security benefits and pension income.
• Flat tax rate: Some states impose a flat tax rate on all retirement income, regardless of the type of income.
• Progressive tax rate: Some states impose a progressive tax rate on retirement income, with higher tax rates applying to higher levels of income.

It’s essential to understand how your state taxes retirement income to plan accordingly and minimize your tax liability. Knowing whether your state offers exemptions or imposes a flat or progressive tax rate can significantly impact your retirement planning.

No income tax on retirement income

Now, there are four states where, even though they usually have an income tax, they cut retirees some slack. Retirement income, which includes the money from 401(k)s, IRAs, and pensions, as well as those Social Security benefits, gets a free pass. Additionally, 33 states, including Arkansas, do not tax military retirement income, making them attractive options for veterans.

Here’s the lowdown on those states:

• Illinois: It’s all clear, no taxes on retirement income.
• Iowa: If you’re 55 or older, you’re in luck, no taxes on that retirement income. Some states, like Arkansas, completely exempt military retirement pay from taxation, which is crucial to consider when planning your retirement.
• Mississippi: Just make sure your retirement plan checks the right boxes, and you won’t have to worry about state taxes on it.
• Pennsylvania: Similar to Mississippi, as long as your retirement plan meets certain criteria, you can keep those taxes at bay.

Which States Don't Tax Social Security?

It’s interesting to note that while 11 states currently tax Social Security benefits, the trend is shifting. Many are in the process of phasing out this tax, which is great news for retirees.

Now, let’s talk about the states where your Social Security retirement benefits can stretch further. In these 39 states plus the District of Columbia, Social Security benefits remain untaxed.

This means more financial freedom and one less thing to worry about during your golden years.

Additionally, some states do not tax Social Security income at all, such as South Dakota, Tennessee, and Iowa, creating a tax-friendly environment for retirees. Other states may offer exemptions for certain demographics, like low-income retirees and military veterans, making it important to consider state tax impacts on your retirement income.

• Alabama
• Alaska
• Arizona
• Arkansas
• California
• Delaware
• Florida
• Georgia
• Hawaii
• Idaho
• Illinois
• Indiana
• Iowa
• Kentucky
• Louisiana
• Maine
• Maryland
• Massachusetts
• Michigan
• Mississippi
• Nevada
• New Hampshire
• New Jersey
• New York
• North Carolina
• North Dakota
• Ohio
• Oklahoma
• Oregon
• Pennsylvania
• South Carolina
• South Dakota
• Tennessee
• Texas
• Virginia
• Washington
• West Virginia
• Wisconsin
• Wyoming

States Which Do Not Tax Retirement Income/Pension

These 15 states don't tax pension income. (Note: Other states may provide a credit or exemption for a portion of pension income.)

• Alabama (does tax 401(k) and IRA distributions)
• Alaska
• Florida
• Hawaii (does tax 401(k) and IRA distributions)
• Illinois
• Iowa
• Mississippi
• Nevada
• New Hampshire
• Pennsylvania
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

Alabama

• Pensions: Alabama does not tax pensions.
• 401(k)s and IRAs: The government taxes 401(k)s and IRAs as regular income, with state rates ranging from 2% to 5%.
• Social Security Benefits: These benefits are exempt from state income tax, offering additional savings for retirees.
• Income Tax Range: The state income tax rates in Alabama range from 2% to 5%, depending on your total income.

Alaska

• Pensions: With no state income tax, pensions are not taxed in Alaska.
• 401(k)s and IRAs: Similarly, these accounts are not subject to state taxes.
• Social Security Benefits: Also not taxed at the state level.
• Income Tax Range: Alaska has no state income tax, so retirees enjoy tax-free retirement income.

Florida

• Pensions: Florida's lack of a state income tax means pensions are not taxed.
• 401(k)s and IRAs: These accounts also benefit from the absence of a state income tax.
• Social Security Benefits: Not taxed by the state, allowing retirees to keep more of their benefits.
• Income Tax Range: There is no state income tax in Florida.

Hawaii

• Pensions: Hawaii exempts pension income from state taxes.
• 401(k)s and IRAs: These are taxed at standard income tax rates.
• Social Security Benefits: Exempt from state income tax, which can be a significant advantage.
• Income Tax Range: While specific rates are not provided, there is a 5% tax on dividends and interest.

Illinois

• Pensions: Not taxed, providing a benefit for retirees.
• 401(k)s and IRAs: Also exempt from state income tax.
• Social Security Benefits: Illinois does not tax Social Security benefits.
• Income Tax Range: Retirees who are not working are not subject to the state's 4.95% flat income tax rate.

Iowa

• Pensions: Not taxed for individuals 55 and older.
• 401(k)s and IRAs: Also not taxed for those 55 and older.
• Social Security Benefits: Exempt from state tax.
• Income Tax Range: No tax on retirement income for those 55 and older.

Mississippi

• Pensions: Not taxed, allowing retirees to keep their full pension income.
• 401(k)s and IRAs: Not taxed.
• Social Security Benefits: Also not taxed.
• Income Tax Range: Mississippi does not tax retirement income.

Nevada

• Pensions: Not taxed because of no state income tax.
• 401(k)s and IRAs: Not taxed.
• Social Security Benefits: Not taxed.
• Income Tax Range: Nevada has no state income tax.

New Hampshire

• Pensions: Not taxed.
• 401(k)s and IRAs: Not taxed.
• Social Security Benefits: Not taxed.
• Income Tax Range: No state income tax on retirement income; however, there is a 5% tax on dividends and interest which is being phased out by 2027.

Pennsylvania

• Pensions: Not taxed for residents 60 and older.
• 401(k)s and IRAs: Not taxed for residents 60 and older.
• Social Security Benefits: Not taxed.
• Income Tax Range: Pennsylvania exempts all forms of retirement income from taxation for residents 60 and older.

For South Dakota, Tennessee, Texas, Washington, and Wyoming, the absence of a state income tax means all forms of retirement income, including pensions, 401(k)s, IRAs, and Social Security benefits, are not subject to state taxation. This makes these states particularly attractive for retirees looking to maximize their income. Always remember, that tax laws can change, and it's wise to consult with a tax professional for the most current information.

Other Tax Considerations for Retirees

In addition to state taxes on retirement income, retirees should also consider other tax implications, such as:

• Federal income taxes: Retirees are still subject to federal income taxes on their retirement income.
• Property taxes: Retirees may be subject to property taxes on their primary residence or other real estate holdings.
• Sales taxes: Retirees may be subject to sales taxes on purchases made in their state of residence.
• Estate taxes: Retirees should consider the potential impact of estate taxes on their heirs.
• Gift taxes: Retirees should consider the potential impact of gift taxes on their heirs.

It’s essential to work with a tax advisor and personal financial planner to understand the tax implications of retirement and develop a comprehensive tax plan. This holistic approach ensures that you can enjoy your retirement years without unexpected financial burdens.

Ready to maximize your retirement savings and minimize your tax burden? Contact our team today for deeper insights and personalized guidance on how state tax laws can impact your retirement income. Don’t leave your financial future to chance—let’s plan smarter together!