Are you looking to maximize your retirement income? Start with the lowest-hanging fruit. That's living in a state that doesn't tax the daylights out of its retired residents. Indeed, some investors are surprised to learn that while several states allow their retirees to live a relatively income-tax-free life, others don't. A handful of states can even be downright financially unfriendly to people past their working years.
With that as the backdrop, here's a rundown of the states that subject at least some retirement income to taxation.
States that tax withdrawals from your retirement account
For the purpose of making this list, know that Social Security income isn't being considered. Most states don't tax Social Security income anyway, and for most of the few that do, this taxation is modest.
Pension income isn't being considered either, although in most cases, states that impose income tax on retirees' retirement income also tax pension income, at least to some degree.
That leaves withdrawals from 401(k) accounts and individual retirement accounts, which, for most investors, will likely be their biggest source of retirement income. That's why you need to know where a particular state stands when it comes to taxing this money before retiring there.
All 27 states below, plus the District of Columbia, currently treat IRA and 401(k) withdrawals as regular taxable income even if you've already reached your full retirement age and are officially retired:
Arizona
Arkansas
California
Colorado
Hawaii
Idaho
Indiana
Kansas
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Minnesota
Missouri
Montana
Nebraska
New York
North Carolina
North Dakota
Ohio
Oregon
Utah
Vermont
Virginia
West Virginia
Wisconsin
This doesn't necessarily mean you'll be paying much (if any) income tax on this income. You'll still be able to make your typical deductions when you file your taxes, lowering your taxable income. Just like wage-earners in their working years, if your total adjusted gross income doesn't exceed certain levels even after your withdrawals, you could sidestep a sizable state-level income tax bill.
That's an unlikely scenario for most investors, though. If you live in one of the 27 states listed above or the District of Columbia, you'll most likely be paying at least something to the state every year.
What about the others? The following 10 states at least partially tax withdrawals from retirement savings accounts but offer differing levels of tax relief:
Alabama
Connecticut
Delaware
Georgia
Michigan
New Jersey
New Mexico
Oklahoma
Rhode Island
South Carolina
Exclusions, deductions, and exemptions can vary quite a bit from one of these states to the next. For instance, in New Jersey, whether or not contributions to a retirement account were elective or required can impact the eventual taxation of withdrawals. In Rhode Island, although distributions from self-funded and self-managed accounts like contributory IRAs are fully taxable, withdrawals from 401(k) accounts may only be partially taxable if you've also met certain age requirements and don't exceed certain income thresholds. Be sure to check each state's specific rules if you intend to retire in one of the states listed above.
Just part of a much bigger financial plan, but an important part
It's something to think about, to be sure, but state taxes aren't the only matter future retirees should consider before making such an important decision. A lower cost of living could offset a greater tax burden. Sometimes, living somewhere you love is worth the higher taxes. Let's also not forget that, compared to the federal income taxes you'll owe regardless of where you live out your golden years, state taxes will usually be markedly lower. Your medical bills could easily be bigger than your state tax bill, which is another matter to think about.
Nevertheless, with most state income tax rates ranging anywhere from 4% to 13%, avoiding these income taxes could save you hundreds if not thousands of dollars per year. For some retirees it's absolutely worth the move, particularly if you hope to live somewhere that suits your intended retirement lifestyle.The $22,924 Social Security bonus most retirees completely overlook
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