One of the key considerations for retirees is the impact of state taxes on their retirement income. The United States presents a diverse tax landscape, with certain states standing out as the most tax-friendly states when it comes to retirement income.
We will explore these tax-friendly states, including the specific types of retirement income that are exempt from taxation on the state level. We will also explore financial tools that offer tax advantages for those in their retirement years.
Whether you are already enjoying retirement or are in the planning stages, this article aims to equip you with valuable information to help you make an informed decision.
By understanding which states do not tax retirement income and how these policies align with your personal situation and goals, you can take a proactive approach to securing a financially sound retirement.
Which States Don’t Tax Retirement Income?
It is important to note that the seven states below do not tax retirement income because they do not have any state income tax. However, residents will still have to pay federal income taxes.
In 2024, the following 13 of the states don’t tax retirement income:
- Alaska
- Florida
- Illinois
- Iowa
- Mississippi
- Nevada
- Pennsylvania
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Instead, these states generate revenue from several other sources. For example, Alaska, South Dakota, and Wyoming rely on the sale of natural resources to keep taxes low for residents. Similarly, because Alaska is rich in oil, it does not have an income tax, estate tax, or state sales tax. However, some municipalities may charge a sale tax, which typically ranges from 1% to 7%, according to Alaska’s Commerce Department.
While retirees in these states may not be obligated to pay income taxes on the state level, they are still obligated to pay federal taxes on their retirement distributions, where applicable.
Which States Don’t Tax Pensions?
The following 15 states do not tax pension income that retirees receive:
- Alabama
- Alaska
- Florida
- Hawaii
- Illinois
- Iowa
- Mississippi
- Nevada
- New Hampshire
- Pennsylvania
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Similarly, Illinois, Pennsylvania, and Mississippi don’t tax IRA or 401k plans.
Which States Don’t Tax Social Security?
Fortunately, most states in the U.S. don’t tax Social Security. The following 39 states do not tax Social Security in retirement:
- 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
If you live in one of the following states, you can expect to pay taxes on your Social Security benefits:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- Utah
- Vermont
Other Ways to Avoid High Taxes in Retirement
Aside from moving, there are plenty of other convenient ways to avoid paying excessive taxes in requirements that don’t require you to uproot your life.
Contribute to a Retirement Account
Making regular contributions to retirement plans like 401(k)s, traditional IRAs, Roth 401(k)s, and Roth IRAs can help you save on taxes. If you contribute to a traditional 401(k) or traditional IRA, the money you can contribute pre-tax. This means that it will lower the taxable income you will pay each tax year.
If you contribute to a Roth 401(k) or Roth IRA, the money you add to these accounts is post-tax, meaning that you will contribute to the retirement account after state and federal taxes are taken out of your paycheck.
Deciding which type of account you want to contribute to depends on whether you want to save on taxes now or later.
Convert to a Roth IRA Account
One advantage of Roth retirement accounts is that all the money that grows in them is 100 percent yours, and when it’s time to start taking withdrawals, you will have 100 percent tax-free income.
For this reason, some retirement experts recommend converting a traditional IRA to a Roth IRA.
After the conversion is complete, your funds will grow tax-free in the Roth account. This means you won’t owe taxes on any retirement account distributions, including any investment gains you might acquire.
Reverse Mortgage
Another way to save on taxes in your retirement years is to use a reverse mortgage. The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM). This reverse mortgage option is insured by the Federal Housing Administration (FHA) and regulated by the U.S. Department of Housing and Urban Development (HUD).
In order to qualify for a reverse mortgage, at least one of the homeowners must be at least 62 years of age, the house they are pursuing a reverse mortgage for must be their primary residence, and they need to have equity in the home.
The HECM reverse mortgage is a loan just like a traditional mortgage. However, instead of making monthly payments to a lender, seniors receive payments from their lender from the equity that they have accumulated in their homes.
The reverse mortgage will pay off the current traditional mortgage, if there still is one. Homeowners can then receive the remaining funds in the form of a lump sum, line of credit, monthly payments, or a combination of the three. These funds can be used to help homeowners cover a variety of costs, including supplementing retirement income and making home upgrades.
How much retirees receive in their reverse mortgage is based on factors like the age of the youngest borrower, the value of the property being mortgaged, and current interest rates.
Fixed-rate borrowers are limited to only receiving their reverse mortgage payments in a single lump sum payment. But if you opt for a reverse mortgage with a variable interest rate, payments can look like:
- Monthly payments to residents of the home
- Monthly payments for a fixed number of months
- A line of credit
- A line of credit and monthly payments
- A lump sum disbursement and monthly payments
- A lump sum disbursement along with a line of credit
Most importantly, the payments received from reverse mortgages are not taxable because it is considered a loan, not income. Plus, when used early enough in retirement, reverse mortgages can provide income to seniors looking to convert their savings into a Roth account. While they go through this process, they can use the money from the reverse mortgage to supplement their income to live on until the conversion is complete.
If you’re interested in applying for a reverse mortgage, here are the steps you can expect:
- Meet with an advisor who will review your finances and let you know if you qualify for a reverse mortgage.
- Attend a counseling session with a HUD-approved counselor who will review the pros and cons of a reverse mortgage.
- Submit your application, which will be processed by underwriting.
- Obtain an appraisal to determine the current market value of your home.
- Schedule a closing date and sign the documents required.
- Receive your reverse mortgage funds in the manner you agreed to in your application.
Reverse mortgages are ideal for those looking to retire in place, but for those who want to relocate, say to move to a state that offers more tax advantages, they can use what’s called a reverse mortgage for purchase, HECM for purchase, or H4P. This allows retirees to combine a large down payment, typically from the sale of their previous home, and combine it with a reverse mortgage loan. This unique product allows older homeowners a way to purchase a new home without having to take on monthly mortgage payments.
Reverse mortgage borrowers are still required to pay property taxes, homeowners insurance, and maintain the home.
Common Types of Retirement Income
Social Security Retirement Benefits
Social Security is a federal government program that provides retirement benefits to eligible individuals. During their working years, both workers and employers pay into the system through payroll taxes.
Individual Retirement Accounts and 401(k)s
The funds contributed to retirement accounts like Roth IRAs allow the retiree to make money through various stocks, bonds, mutual funds, and other investments that can grow over time and serve as tax-free money when retirement rolls around.
Annuities and CDs
Annuities and CDs (Certificates of Deposit) are two other financial products that can provide a source of income in retirement.
An annuity is when an individual makes payments to an insurance company that guarantees a stream of income over a period of time. Annuities are offered with fixed or variable interest rates, some even offering the option of inflation-adjusted payments to help protect against inflation.
Meanwhile, CDs are savings accounts that offer a fixed interest rate for a fixed term. Individuals who invest in CDs agree to keep their money in the account for a set period of time, earning them a guaranteed fixed interest rate on their investment.
Pensions
Many employers offer pensions as part of a retirement plan. Pensions provide a guaranteed source of income by setting aside funds from a worker’s paychecks over the years that they work. Unlike other retirement accounts, such as 401(k)s and IRAs, the amount of income received from a pension is not dependent on investment returns or market performance.
Property
Selling your property can be a source of income if you are looking to downsize in retirement. Similarly, property can provide access to a reverse mortgage in retirement, as explained earlier.
Bottom Line
Understanding the tax implications of retirement income across different states is a step of retirement planning that should not be overlooked. By choosing to retire in states like Alaska, Florida, Nevada, and others listed, retirees can significantly reduce their state tax burden, though federal taxes remain a consideration.
Additionally, strategies such as contributing to retirement accounts, converting to Roth accounts, and considering reverse mortgages offer further avenues to optimize cash flow in retirement.
As you navigate these choices, it’s always recommended to consult a financial advisor or financial planner who specializes in retirement income strategies so that you can be sure that you are making an informed decision.
Reverse mortgage borrower must occupy home as primary residence and remain current on property taxes, homeowner’s insurance, the costs of home maintenance, and any HOA fees.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.
