Your Retirement, Your Taxes: Choose Wisely
Key Financial Considerations for Retirees
After decades of contributing to your retirement funds and Social Security, the thought of substantial tax obligations can be daunting. Fortunately, not all states approach retirement income with the same tax policies. While federal taxes are a constant, some states offer considerable tax relief to retirees. This distinction is crucial for maximizing your retirement savings and ensuring a comfortable post-career life.
Arkansas: A Haven for Retirement Savings
Arkansas provides a welcoming tax landscape for retirees, offering several exemptions that can significantly reduce their tax burden. The state exempts up to $6,000 annually from both public and private employer-sponsored pension plans, as well as IRA distributions received after age 59½, or due to death or disability. Additionally, Social Security income and military retirement pay are entirely exempt from state taxes. Arkansas further enhances its appeal by having no estate or inheritance taxes, which means your legacy can be passed on to heirs without additional tax complications.
Illinois: Extensive Tax Relief for Retirees
Illinois stands out as another state highly favorable to retirees due to its comprehensive tax exemptions. The state entirely exempts pension income, 401(k) and IRA withdrawals, Social Security benefits, and military retirement pay from state taxes. While Illinois does tax other investment earnings, and also imposes estate and inheritance taxes, the broad exemptions for retirement income make it an attractive option for many.
Iowa: Embracing a More Retirement-Friendly Tax System
Iowa has recently transformed its tax laws to be more accommodating for retirees, making it an increasingly appealing destination. Effective January 2023, the state no longer taxes pension, 401(k), or IRA income for residents aged 55 and older, allowing eligible individuals to enjoy tax-free retirement income at an earlier age. Looking ahead, Iowa transitioned from a graduated tax system to a flat tax system with a rate of 3.8% as of January 1, 2025. Furthermore, the state abolished its inheritance tax, effective the same date, providing additional financial benefits for retirees and their families.
Mississippi: Comprehensive Exemptions for Retirement Funds
Mississippi offers a robust tax-friendly environment for retirees by exempting various forms of retirement income from state taxes. This includes distributions from retirement plans, pension income, Social Security income, and military retirement pay. However, it's important to note that early distributions from retirement plans typically do not qualify for these exemptions. Adding to its financial attractiveness, Mississippi does not impose estate or inheritance taxes, further safeguarding retirees' assets.
New Hampshire: Enhancing Tax Benefits for Seniors
New Hampshire presents a unique and increasingly favorable tax situation for retirees. The state does not tax Social Security benefits or pension income. While it previously taxed retirement account distributions that qualified as interest or dividends, this tax was repealed as of January 1, 2025, making New Hampshire even more attractive. Since New Hampshire already has no income tax on earned wages, most distributions are exempt as they are considered income. The absence of estate and inheritance taxes further solidifies New Hampshire's position as a tax-friendly state for retirement.
Pennsylvania: A Low-Tax Option for Retirees
Pennsylvania offers significant tax advantages for retirees, characterized by the absence of state taxes on Social Security, pension income, and retirement plan distributions. Beyond these exemptions, Pennsylvania boasts one of the nation's lowest flat income tax rates on earned wages, at just 3.07%. Adding to its appeal, eligible retirees in Pennsylvania can also take advantage of a property tax/rent rebate program, providing additional financial relief.
South Carolina: Tax Advantages for Military and Older Retirees
South Carolina is a state that provides distinct tax benefits for retirees, especially military personnel and those over 65. The state does not tax Social Security income. For tax year 2022 onwards, all military retirement pay is exempt from state income taxes. Retirees aged 65 and older can exempt the first $10,000 of retirement plan income from state tax, while those under 65 can exempt $3,000. Additionally, South Carolina offers a $15,000 state tax deduction for residents aged 65 and above, making it an attractive option for many seniors.
States with No General Income Tax
For individuals residing or working in any of the following nine states, state income taxes on retirement earnings are entirely absent. This offers an automatic financial advantage for retirees, allowing them to keep all of their retirement income. However, it's important to recognize that these states may offset the lack of income tax with other forms of taxation, such as property or sales taxes.
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington (taxes only capital gains of high earners)
- Wyoming
These states provide substantial tax relief, though understanding their broader tax structures is key for a holistic financial plan.
Taxation of Pension Income by Age
In the United States, there's no specific age at which pension income becomes entirely tax-exempt. Pension taxes are not determined by age but rather by federal and state regulations. Most pensions are subject to federal income tax, and many are also subject to state income tax, depending on the state of residence. Additionally, individuals must begin taking required minimum distributions (RMDs) from tax-deferred accounts at age 73.
Strategies for Reducing Retirement Taxes
To minimize your tax burden in retirement, strategic planning is essential. A key approach involves carefully sequencing your withdrawals: prioritize withdrawals from taxable accounts first, followed by tax-deferred accounts such as 401(k)s and IRAs. This allows tax-advantaged savings to continue growing for longer, effectively deferring taxes. Consider converting some traditional IRA funds to a Roth IRA before RMDs begin at age 73, as Roth IRAs are exempt from RMDs and qualified withdrawals are tax-free. Delaying Social Security benefits until age 70 can increase your monthly payments and potentially reduce early-retirement taxes. Charitable donations can also provide tax benefits. Finally, choosing to live in a tax-friendly state and taking advantage of eligible medical deductions can further reduce your tax liabilities.
Social Security Benefits and Taxation in Retirement
The taxation of Social Security benefits during retirement depends on your overall income. If your combined income (which includes Social Security benefits, non-taxable interest, and adjusted gross income) exceeds specific thresholds, a portion of your benefits may be subject to income tax. For single filers, if your combined income falls between $25,000 and $34,000, up to 50% of your Social Security benefits may be taxed. If your combined income is above $34,000, up to 85% of your benefits could be taxable.