Best Places to Retire

The Basics 
Which states give retirees the best deal? 
If you’re thinking about retiring to a state with no income tax, look further. Other taxes could mean you’ll pay more, not less. Here’s how they all stack up.
By Kiplinger’s 

Some states are tax-friendly for retirees, others are tax-foul.

Location, location, location — the cardinal rule of real estate — has a mighty impact on your tax bill in retirement, too. But it may not be in the ways you would expect. For retirees living on a fixed income, taxes can claim an increasing share of their household budget each year, causing some to ponder a move to Florida or Texas, which impose no state income tax. But does income-tax-free translate into a lower cost of living? Don’t bet your retirement lifestyle on it.

Kiplinger’s magazine has developed a retiree’s tax map to illustrate the total tax burden — income taxes, property taxes and sales taxes — for a typical retired couple in each of the 50 states and Washington, D.C. We discovered that when you look at the big picture, it might be cheaper to stay put in New York or Illinois than to move to one of the no-tax “havens.” For retirees who are really retired — that is, who haven’t taken on jobs in retirement — income taxes are often the least of their worries.

A recent advertisement for retirement homes in Pennsylvania included the tantalizing enticement that retirement income is not taxed in the Keystone State. That’s true. Pennsylvania, which has a broad-based state income tax, is one of the most generous states in the country when it comes to the tax treatment of retirement income. Social Security benefits, public and private pensions as well as IRA distributions are all exempt from state income tax. But don’t pack your bags just yet. When we tabulated the total state and local tax burden for retirees in all 50 state capitals and Washington, D.C., Harrisburg, Pa., proved to be the most taxing city for retirees.

Welcome to the real world, where property taxes can make homeownership the biggest burden of all in your golden years. Add to that sales tax, which you pay as you go about your daily errands, and you’ll start thinking about the tax bogeyman in a whole new light. 

In our example, property taxes of more than $6,500 on a median-priced home in Harrisburg (the highest property-tax bill in our survey) pushed Pennsylvania to the bottom of the list of tax-friendly places. And that’s despite a zero income tax bill because all of the couple’s retirement income is exempt from Pennsylvania’s taxes and their remaining $5,000 of interest and dividend income falls below tax thresholds. 

You might expect that Pennsylvania, second only to Florida in its percentage of residents 65 and older, would cut seniors some slack. While it does offer a property-tax rebate of up to $500 to some older homeowners, our hypothetical couple’s $60,000 income was too high to qualify.

The retirement tax bite, state by state

State has no income tax. **Florida has no income tax. The $160 figure includes an intangibles tax.

Make taxes a consideration
“When people are considering a retirement relocation destination, I think most of them focus too much on income taxes,” says Robert Barbetti, senior manager of JP Morgan Private Bank’s Advice Lab. “I think they should definitely look at the property-tax situation. While many states might exclude some or all of your pension from income taxes, property taxes go on — and often up — year after year.”

One word of caution: Our estimates are based on taxes in state capital cities. Since property taxes are local, they can differ widely from city to city, and even from neighborhood to neighborhood. So our tax estimates for the state capitals may not reflect those of other cities within the same state.

“Many people believe that no state income tax means lower overall taxes, but this is not necessarily true,” says Eve Evans, co-author of “America’s Best Low-Tax Retirement Towns” (Vacation Publications, $16.95). “In several cases, our research shows that the states without an income tax make up the difference with higher rates for property taxes, sales taxes and other tax categories.” Are you surprised by that?

Even traditional “no-income-tax” retirement meccas, such as Florida, Washington and Texas, ranked only in the middle of our survey — at Nos. 27, 28 and 29, respectively — because of property and sales taxes. Take a look at our retiree tax map and you may be surprised which cities turn out to be tax havens — or hells. If you’re curious about how you would fare under another state’s income-tax rules, go to taxsites.com. (See link at left.) Then, click on “state and local tax” and then the state of your choice to download state-income-tax forms and instructions. (You can also get state tax form on MSN Money at the State tax forms page.) 

Adding it all up
Kiplinger’s map is a snapshot of what the total annual state and local tax burden — income, property and sales taxes — would be in the capital of each state and in the nation’s capital for a retired husband and wife who are both age 65. We assume an annual income of $60,000, of which $24,000 comes from Social Security benefits, $21,000 from a private company pension, $10,000 from IRA distributions, and $5,000 from taxable interest and dividends. Our hypothetical couple also own their home outright, so there’s no mortgage interest to pay or to deduct on their tax returns.

Sperling’s Best Places, an online service that lets you compare cities by climate, cost of living, crime rate, and access to cultural and leisure activities, compiled a list of median sale prices for a 2,000-square-foot home sold last year in each of the 51 cities. (To access that site, clink on the link at left under “Related Web Sites.”) With those prices in hand, we contacted the real estate taxing authority in each jurisdiction to develop property-tax estimates, cranking in any special money-saving exemptions for older residents whenever our hypothetical couple qualified.

State and local sales-tax rates were supplied by CCH, the Chicago publisher of authoritative tax information. We assume our couple spends $20,000 a year on taxable items, such as clothing, groceries, household goods, entertainment and restaurants. We factored in exemptions and different tax rates that applied to specific spending categories. We did not include prescription drugs and medical services, which are generally not subject to sales tax (the exception is Illinois, where prescription drugs are taxed at 1%). We also excluded utilities from our sales-tax calculation because they often carry their own fees and taxes that are imbedded in the monthly bill.

We assume our couple spend about $10,000 a year on premiums for home, auto, long-term-care and supplemental health insurance, and that they donate $4,200, or 7% of their yearly gross income, to charity. Expenses such as long-term-care insurance premiums and charitable contributions helped to reduce our retirees’ income-tax bill in some states. We used H&R Block’s TaxCut software to figure the couple’s state-tax liability for all 43 states that have a state income tax and the District of Columbia, based on 2001 rules. Itemized deductions were used when they produced a lower tax bill. Otherwise, we used the standard deduction.

Personal-property taxes, such as the controversial “car tax” that about a dozen states impose on the value of items like cars and boats each year, are not included in our calculations.

The winners …
Okay, we won’t keep you in suspense any longer. It’s no secret that corporations love to set up shop in tax-friendly Delaware. Now retirees might want to do the same. Our hypothetical retired couple in Dover, Del., doesn’t spend a dime on sales taxes (there are none). Social Security benefits are spared the state levy, and up to $12,500 per person of other retirement income is tax-free. Our couple’s only tax obligation is a $543 property-tax bill on their $133,000 home, making the First State first on our list of tax-friendly locations for retirees.

Next on the list is Alaska, but it’s a distant second — literally. Although Alaska has no state income tax or sales tax and the capital city of Juneau waives its 5% local sales tax for residents 65 and older, housing prices have skyrocketed recently, and so have property taxes. The median sale price of a 2,000-square-foot home in Juneau last year was $240,000. Most residents would owe more than $2,700 in property taxes, and even with a $150,000 exclusion for senior citizens, our retired couple owes $1,032.

But it’s unlikely that many retirees are going to pack up and move to the land of the midnight sun. Climate, cost of living, leisure activities, medical facilities, and proximity to family and friends are all factors to consider when planning a retirement move. 

Although both Kentucky and South Carolina impose an income tax, generous retirement-income exemptions mean our retired couple owes no income tax in either state. Frankfort, Ky., ranks No. 3 on our map. It excludes food from its 6% state sales tax and levies a low $274 property tax on a $163,000 home, for a total tax bill of $1,114. Although Columbia, S.C., has a lower statewide sales tax of 5%, it does tax food. Together with a property-tax bill of $518 on a $128,000 home, the couple’s total tax bill in the Palmetto State is $1,518, placing it in the No. 4 slot.

You may be surprised that Albany, N.Y., ranks No. 5 in our tax-friendly survey. Empire State retirees can exclude from state taxes up to $20,000 per person of retirement income, including private pensions, annuities, IRA distributions and Keogh-plan withdrawals. Pensions from New York State and local governments, the military and the federal government are exempt. So our retired couple owes no state income tax. With a combined state and local sales tax of 8%, our retired Albany residents pay an estimated $1,120 a year on purchases, excluding food. With a generous senior exemption through the statewide Star program, their property tax is $912 on a $120,000 home, for a total of $2,032 in New York State and local taxes.

No. 6 on the top 10 tax-friendly list is Lansing, Mich., with a total tax bill of $2,152, thanks to the state-income-tax exemption of up to $72,180 of private pension income per couple. Jackson, Miss., which exempts all public and private pension income, ranks seventh, with a total tax bill of $2,185. Cheyenne, Wyo., and Carson City, Nev. (neither has a state income tax), take the eighth and ninth spots with total tax bills of $2,207 and $2,326, respectively. Denver rounds out the list at No. 10, with a retiree tax bill of $2,397.

… And the losers
While Pennsylvania’s high property taxes put it firmly in last place, with a total state and local tax burden of $7,531, neighboring Trenton, N.J., is not far behind. High property taxes of $5,788 boost our couple’s total tax obligation in the Garden State to $6,715, placing it in the No. 50 slot. That’s despite New Jersey’s generous tax treatment of pension income. Taxpayers 62 and older can exclude up to $15,000 of pension income per couple and can apply the unclaimed portion of the exclusion to other types of income. And they can deduct their property taxes on their state tax return.

Madison, Wis., ranks 49, after taxing all of our couple’s private pension and levying a nearly $4,000 property-tax bill. Together with the combined 5.5% state and local sales tax, “America’s Dairyland” milks our couple for $6,016 in total state and local taxes. No. 48 on our retiree tax map is Vermont. It offers retirees no break on their retirement income or Social Security benefits and levies more than $4,000 in property taxes on a $124,000 home. Including a 5% statewide sales tax, our couple owes the Green Mountain State $5,822.

Annapolis demonstrates that there’s no free lunch in the “Free State” of Maryland as its 5% state sales tax is applied to most purchases, including some groceries. It ranks 47 on our list, mainly because of a hefty property-tax bill of $3,483, based on a 100% assessment of the market value of a $275,500 house (the third most expensive median-priced home in our survey, after Honolulu and Santa Fe). While Maryland offers a generous pension exemption of up to $17,300, the city of Annapolis imposes its own income tax, bringing the total income-tax bill to $1,238. Had our couple been eligible for a one-time-only tax credit of up to $500 per person for purchasing long-term-care insurance, their income-tax bill would have dropped to $466, which would have boosted Maryland four spots to No. 43 in our list.

Concord, N.H., joins our list of the 10 most tax-foul cities for retirees. Although New Hampshire has no sales tax and imposes income taxes only on interest and dividends, a whopping $5,279 property-tax bill on a $193,090 house drops Concord into the No. 46 position. Little Rock, Ark., with a state-income-tax bill of $2,241 — the second-highest in our survey — ranks 45. Augusta, Maine, with a steep property-tax bill of more than $3,600 on a $153,500 house, ranks 44. Rounding out our list of least tax-friendly cities for retirees are Providence, R.I., and Bismarck, N.D.

Breaks for retirees
It is not so much what a state taxes but what it spares from taxation that makes or breaks a total tax bill for most retirees. For example, to prevent elderly homeowners from being forced out of their homes by rising property taxes, states often provide relief to seniors in the form of a homestead exemption, a freeze on the property’s value or a deferral of property taxes, says E. Thomas Wetzel, president of the Retirement Living Information Center. (See link to its Web site under “Related Web Sites” at left.) The majority of these programs are targeted to low-income households. Still, in Alabama, Alaska, Hawaii, Illinois, Mississippi, New York, Texas and Washington, D.C., a couple with $60,000 in income qualifies for such a property-tax break designed specifically for seniors.

In most cities, the local property tax is determined by multiplying the assessed value of a home by a property-tax rate. But assessments in the cities we surveyed ranged from a low of 4% of market value in Columbia, S.C., to 100% in several cities. So if you’re thinking about relocating, don’t forget to check out the property taxes. In some cases, redirecting your home search down the street or across county lines could save you a bundle.

Most of the 43 states that impose an income tax, as well as the District of Columbia, exempt at least some pension income. Different types of pensions — private, military, federal civil service and state or local government — are often treated differently, with public pensions usually benefiting from the most generous exclusions. Unlike Uncle Sam, who taxes up to 85% of Social Security benefits, more than half of the states exempt Social Security income from taxation. For detailed information on how individual states tax Social Security and pension benefits, see State Taxation of Social Security and Pensions in 2000 on the AARP’s Web site. (For more, click under “Related Web Sites” at left.)

Thanks to generous retirement-income exclusions, our hypothetical couple — who rely on Social Security, private pension payments, IRA distributions and investment income — pay no income tax in eight states that have a state income tax: Delaware, Illinois, Kentucky, Michigan, New Hampshire, New York, South Carolina and Tennessee. New Hampshire and Tennessee tax only interest and dividends, but since our couple’s $5,000 in interest and dividends is their only taxable income, they do not reach the minimum income to owe tax in those two states.

Ironically, they would owe a special tax to no-income-tax Florida because the Sunshine State imposes an intangibles tax on a laundry list of assets, including stocks, bonds and mutual funds, at a rate of $1 per $1,000 for a married couple’s assets in excess of $40,000. But the tax is not as onerous as it sounds because money-market accounts, certificates of deposit, IRAs, annuities, retirement plans, cash-value life insurance policies and Florida bonds are exempt. So assuming half of our retired couple’s $400,000 portfolio is in IRAs and other excluded assets, they have to pay a Florida intangibles tax of only $160. 

So set your mind at ease. State income taxes won’t be your financial downfall, although depending on where you live, property taxes might. In only three jurisdictions — Little Rock, Ark., Washington, D.C., and Helena, Mont. — did our retired couple’s income-tax bill exceed $2,000. Property taxes were at least that high in 19 cities, with four of them topping $4,000 a year. If you are planning to relocate when you retire, check out the total tax picture of your new home before you move, and consult a local tax expert to see if you can reduce your tax liability in your new state.

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