Americans nearing retirement may be looking to so-called “tax-friendly” states in hopes of further increasing their savings. This often means moving to one of the states with no income tax (including Florida, Texas, and Tennessee), or where retirement income such as pensions, IRAs, and Social Security benefits are tax-free.
In theory, the strategy may seem convincing. Fidelity estimates (1) that if a couple withdraws $100,000 from an IRA, they could pay about $5,300 less in taxes per year in a low-tax state like Iowa than in a high-tax state like Oregon. For those who spend decades in retirement, the difference can reach up to six figures if you invest wisely.
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But financial planners say many retirees focus too narrowly on income taxes and overlook broader living expenses such as property taxes, sales taxes and insurance premiums. In some cases, moving to a state with no income tax may not actually reduce your total expenses at all.
“Don’t let taxes derail your lifestyle,” Matt Chancey, a Florida-based certified financial planner, told MarketWatch (2). “Those who are purely motivated by taxes are solving the wrong problem.”
Here’s what retirees need to know before preparing for a “tax-friendly” move.
Just because you don’t pay income tax doesn’t necessarily mean your taxes are low.
Take Texas, for example. The state has no personal income tax, making it attractive to retirees who receive significant income from traditional IRAs and 401(k)s. However, Texas relies heavily on local property taxes to fund government services. The Texas Comptroller notes that property taxes are locally administered and can vary widely by county and taxing district (3).
Homeowners may qualify for the homeowner’s exemption, which reduces the value of their home on tax, but retirees who own expensive homes can still face a hefty tax bill each year.
A similar tradeoff exists in Florida. Although the state has no income tax, it generates significant revenue through sales taxes (4), tourism taxes, and property taxes. Florida’s statewide sales tax rate is 6%, with local taxes on top of that in many counties.
That means retirees who spend a lot on travel, food, home maintenance or big-ticket purchases may end up paying more in taxes than they expected, even without state income taxes.
On the other hand, some states with income taxes are surprisingly retirement-friendly. Illinois, Pennsylvania, and Iowa all exempt many forms of retirement income (5) from taxes, including pensions, IRA withdrawals, and Social Security benefits.
Read more: Taxes will change under President Trump’s ‘Big and Beautiful Bill’ — 4 reasons you can’t afford to waste time
Retirement accounts are more important than you think
Whether moving will actually save you money depends largely on how your retirement income is structured.
Traditional IRAs and 401(k)s are taxed as ordinary income once withdrawals begin, making retirees more sensitive to state income tax rates. That’s why high-income retirees who receive higher required minimum distributions may benefit more by moving to a lower-tax state.
However, retirees who rely primarily on Roth IRAs may see little benefit in making the move solely for tax reasons, since qualified Roth withdrawals are already tax-free under federal law.
Overlooking federal taxes can also negatively impact your plans. Federal taxes are typically your biggest tax liability in retirement, regardless of where you live. Although state taxes may seem more visible, they are often secondary to federal income taxes, Medicare premiums, and medical costs.
And at the end of the day, taxes are only one part of retirement planning. Access to health care, proximity to family, housing affordability, and lifestyle preferences can be far more important in 20 or 30 years of retirement than cutting a few percentage points in taxes.
As multiple advisors told MarketWatch (2), the best retirement choice is often not just the one with the lowest income tax rate, but the one that balances both financial efficiency and quality of life.
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Fidelity Investments (1); MarketWatch (2); Texas Comptroller of Public Accounts (3); Florida Department of Revenue (4); Kiplinger (5)
This article originally appeared on Moneywise.com with the title “Don’t let your tax tail swing over your lifestyle”: Moving to a state with no income tax in retirement can lead to other problems
This article is for information only and should not be construed as advice. PROVIDED WITHOUT WARRANTY OF ANY KIND.
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