Thursday, May 1, 2014

Surprising Tax Havens at Retirement

Accepted wisdom: Tax-averse retirees should move to Florida or Nevada, which have no state income or estate taxes. But what if you don’t worship the sun or relish a long-distance move? In recent years other states, too, have been lavishing tax goodies on retirees, including affluent ones. With a little research you might discover your own retirement tax haven is close to home.

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State tax laws discriminate based on age, and that can be a good thing for some taxpayers. Even notoriously high tax states can be tax havens for retirees. In fact, Florida and other retiree magnets might not be the tax havens they are promoted as when the full tax picture is considered. Florida has no income tax, but it does have high sales and property taxes (at least for some property owners), and its high homeowner's insurance premiums can be considered a tax for living in the Sunshine State.

Forbes magazine recently published a survey of some surprising retiree tax havens. The details of the tax laws in many states can be eye-opening.

Michigan, for example, exempts $81,840 of private retirement income per married couple plus Social Security benefits from its income tax. That makes the state an overlooked tax haven for retirees.

Illinois, Mississippi, and Pennsylvania exempt 100% of private and public retirement income (including IRA distributions). These states impose neither a ceiling nor a minimum age on their exemptions. Alabama and Hawaii have unlimited exemptions for payouts from traditional pension plans but do not provide any exemption for IRA distributions.

Only 15 states tax Social Security benefits to some extent; the rest exempt it.

A number of states allow retirees exemptions for income up to a specific amount. Colorado taxes Social Security but exempts the first $48,000 of income for those 65 and older and $40,000 for those 55 to 64. Georgia exempts the first $60,000 of income, including investment income, for those 62 and older.

Because of these exemptions and other details, it pays to look at the details of a state's tax law before concluding whether or not it is a retiree tax haven. New Hampshire has no sales tax and is commonly regarded as a tax haven. But it takes investment income and its real estate taxes are sky high. Tennessee does not have a broad income tax but taxes investment income. That means in many cases its retirees will pay higher state taxes than those drawing pay checks.

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If you are considering a move in retirement or want to know the full cost of the retirement location you chose, examine these five key factors.

Social Security is your base retirement income. Determine if your state is one of the few that still taxes all or part of the benefits. Seven states piggyback on the federal tax code and tax up to 85% of benefits. Eight states tax lesser amounts. The others exempt the benefits.

Pension and retirement account income might be exempt in full or in part. As we discussed a few states fully exempt retirement income. Many have a partial exemption, but you have to read the details. It is common for a state to exempt only traditional defined benefit pension payouts, not IRA and 401(k) distributions. Some give government pensions a bigger break than private pensions. A minority of states gives IRA distributions or other nontraditional retirement savings breaks similar to those for other pensions.

Note that if you move in retirement your old state of residence no longer can try to tax your pension or IRA distributions in retirement. But non-qualified deferred compensation might be reachable by the old state.

Take a look at how other income is taxed and at any miscellaneous tax breaks. Some states give seniors special exemptions for investment income or allow deductions for various expenses, including contributions to 529 plans for the grand-kids. Others effectively impose penalties on retirees, for example by taxing capital gains and investment income at higher rates than other income.

Real estate and sales taxes can be significant expenses. Some states and localities reduce or defer property taxes for seniors. Others finance most of their government spending through these taxes, and they are high. In some states, taxes on a home can jump significantly for a new owner.

Estate and inheritance taxes are a factor in only 23 states now. The taxes can be higher than federal counterparts in many of these states, so study the effects carefully before moving.

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To find low-tax places to retire, U.S. News & World Report cranked up its Best Places to Retire search tool. U.S. News sifted through more than 2,000 U.S. places to find locales that have relatively low taxes but also offer amenities important to retirees, such as a reasonable cost of living and fine recreational and cultural choices. Many of the low-tax retirement havens have no state sales tax, such as Billings, Mont., or no state income tax, such as Sioux Falls, S.D. There's nothing like zero tax to make your retirement dollar go further.

One low-tax retirement gem, Stafford, Texas, a suburb of Houston, eliminated its property tax in 1995. Texas is also one of seven states with no income tax. (The others are Alaska, Florida, Nevada, South Dakota, Washington and Wyoming.) Stafford also has the lowest sales tax in the Houston area.

Seniors looking to maximize their fixed income may also want to give Manchester, N.H., a look. There is no sales tax or traditional income tax, but New Hampshire does levy a 5% tax on interest and dividend income of more than $2,400 annually ($4,800 for couples). Residents ages 65 and older pay tax only on amounts of more than $3,600, and that's outside your retirement accounts. Withdrawals from retirement accounts are not taxed in New Hampshire.

Many retirement locales offer tax perks specifically for seniors. Nashville-Davidson County, Tenn., for example, was the first jurisdiction in the state to allow homeowners who are 65 or older and who earn less than a certain income level — $35,390 in 2007 — to freeze the amount of property tax due on their primary residence in the year they qualify, even if tax rates increase later. The frozen dollar amount will rise if the owner sells or makes improvements to the house. If the house drops in value and the current taxes become lower than the frozen amount, homeowners pay the lower amount. And like New Hampshire, Tennessee also doesn't tax earned income, just dividends and interest.

Low-tax towns don't have to be dull. Doral, Fla., is home to the Doral Golf Resort & Spa, which hosts a PGA tournament every year. And Henderson, Nev., Las Vegas' less glittery cousin, is only a short drive from the Strip, Hoover Dam and Lake Mead. Businesses often flock to tax-friendly cities. And thriving local economies are sure to help retirees find second careers and start small businesses. The business-friendly tax structure of Spokane, Wash., is key to attracting prime technology jobs to the area. After work, retirees can stroll along the Spokane River, which runs through the center of town, or hike in the nearby mountains.

Some cities, like Cheyenne, Wyo., try to slash their budgets rather than increase taxes. In October, Cheyenne Mayor Jack Spiker announced a hiring freeze on nonessential personnel, a reduction of out-of-town travel and a review of equipment expenditures. "Just like taxpayers, the city needs to tighten its financial belt during these times of economic uncertainty," he says. By leaving vacant positions open until the end of the year, the city estimates it will save $3,160 a month per entry-level employee and $5,050 a month for each vacant mid-level position.

Perhaps the most tax-friendly state for retirees is Alaska. The largest state in the union is the only one without any kind of income or sales tax. The city of Juneau levies a 5% sales tax, but people 65 and older who have lived in the city for at least 30 days and plan to remain indefinitely in the state can get a Senior Sales Tax Exemption Card for a $20 application fee. Those over 65 may also be eligible for a senior-citizen property tax exemption on the first $150,000 of assessed value. All Alaska residents with at least one year in the state also receive annual Alaska Permanent Fund dividends. The payout was an unusually high $3,269 in 2008, but even more typical dividends have been nothing to scoff at, ranging from $827 to $1,964 over the past two decades. This dividend may be taxed as income on federal tax returns.

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