The less money you pay in taxes, the better, when you're living on a fixed income, and some states are more tax-friendly than others. Three main types of state taxes—income tax, property tax, and sales tax—interact to determine the most tax-friendly states if you're retired or you're about to retire.
States With No Income Tax
Eight states don't impose an income tax on earned income as of 2021: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. New Hampshire and Tennessee only tax dividend and interest income, so you can hold down a side job in these two states without it costing you in taxes. Tennessee's tax was the latest to be repealed, which occurred on Jan. 1, 2021.
States that lack an income tax might seem like an attractive option, but many collect revenues in other ways. They might have steep property or sales taxes, which can easily offset the lack of an income tax.
State Income Tax Breaks for Retirees
Most states that do have an income tax also allow retirees to exclude some or all of their Social Security benefits and pension incomes from taxation. Twelve states exempt pension income entirely for qualified retirees:
- New Hampshire
- South Dakota
An additional 24 states exempt or provide a credit for a portion of pension income:
- New Jersey
- New Mexico
- New York
- South Carolina
States You Might Want to Avoid
A few states are less hospitable to retirees. Not only are some of their tax rates high, but they also fully tax pension income, as well as 401(k) and IRA distributions. According to the Tax Foundation, a nonpartisan tax research group in Washington, D.C., these states and their top tax rates as of 2020 are:
- California: 13.3% on incomes over $1 million ($1,181,484 for married filers of joint returns), but Social Security benefits aren't taxed here
- Minnesota: 9.85% on incomes over $164,400 ($273,470 for married filers of joint returns)
- Vermont: 8.75% on incomes over $200,200 ($243,750 for married filers of joint returns)
- Idaho: 6.93% on incomes over $11,554 ($23,108 for married filers of joint returns), but Social Security benefits that are included on a federal return aren't taxed
- Connecticut: 6.99% on incomes over $500,000 ($1 million for married filers of joint returns)
- Nebraska: 6.84% on income over $31,750 ($63,500 for married filers of joint returns)
- West Virginia: 6.5% on income over $60,000 (for single filers and married filers of joint returns)
- Rhode Island: 5.99% on income over $148,350 (for single filers and married filers of joint returns)
- Kansas: 5.7% on income over $30,000 ($60,000 for married filers of joint returns)
- North Carolina: 5.25% on all income, but Social Security benefits aren't taxed
- Massachusetts: 5% on all income, but Social Security benefits included in federal income aren't taxed
- Arizona: 4.5% on income over $159,000 ($318,000 for married joint filers) but Social Security benefits that are included on a federal return aren't taxed
- Indiana: 3.23% on all income, but Social Security benefits aren't taxed
- North Dakota: 2.9% on income over $433,200 (for single filers and married filers of joint returns)
California will tax you at 8% as of 2020—one of the highest rates in the country—on income over $45,753.
Property Tax Relief
Property taxes can be a burden for retirees with low incomes and high housing costs. Fortunately, all 50 states offer some type of property tax relief program.
Forty states provide homestead exemptions that reduce the assessed value of your home, or property tax credits that will reduce your tax bill directly. Most states also have special exemptions for senior residents over a certain age and who meet income requirements.
According to Tax-Rates.org, people living in Louisiana, Hawaii, Alabama, Delaware, the District of Columbia, and West Virginia paid the least property taxes compared to their home's value. Notably, Nevada’s property tax is based on a mere 35% of the fair market value of the property while most states use 100% of fair market value.
States With the Lowest Sales Taxes
Only four states don't have a sales tax: Delaware, Montana, New Hampshire, and Oregon. Alaska comes close—it doesn't impose a state sales tax, but it does allow cities and counties to levy sales taxes at an average rate of 1.76%.
After Alaska, the four states with the lowest combined state and local sales tax rates as of 2020 are:
- Hawaii: 4.44%
- Wyoming: 5.34%
- Wisconsin: 5.43%
- Maine: 5.5%
The five states with the most prohibitive combined state and local sales tax rates as of 2020 are:
- Tennessee: 9.55%
- Arkansas: 9.53%
- Louisiana: 9.52%
- Washington: 9.23%
- Alabama: 9.22%
Income taxes might be your first priority if you expect to have a fair bit of income or will continue to work part time after retirement. Property and sales taxes might be more of a concern if you'll be living on Social Security, which is exempt in many states.
The state with the best overall tax climate for retired persons depends on the type and the amount of your income, the value of your home, your cash on hand, and any specific tax issues you might have.
Some states show clear advantages, however. These include those that have no income tax, that exempt pensions and Social Security income, and states that also have low property and sales taxes.
Note that this list is for general use. It doesn't take climate, access to quality medical care, or cost of living into account. Your financial outlook and what's important to you in a retirement community will determine your unique fit in a retirement destination. Contact your CPA or financial advisor for more personalized guidance on this topic.
Which States Don't Tax 401(k) Withdrawals?
The states that don't tax pension plans extend those same benefits to retirees with 401(k) plans. Your 401(k) withdrawals won't be taxed in Alaska, Florida, Illinois, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming.
How Much Do You Save in Retirement by Living in a State With Lower Taxes?
The more money you have to withdraw in retirement, the more potential you have to save on your tax bill. Someone who withdraws $1.5 million per year could save 13.3% by moving from California to a state without an income tax, like Wyoming. That's nearly $200,000 in savings every year. However, most people won't withdraw more than a million dollars every year in retirement, so their tax brackets (and potential savings by moving to a low-tax state) are much lower.