Consider Tax Constraints Before Moving

Physician's Money Digest, January 2006, Volume 13, Issue 1

According to the AARP, a growingnumber of retired Americansare rethinking and revitalizingtheir lives by trying new careersand returning to school. Oftentimes,these plans also include a change ofaddress. Retirees frequently weigh factorssuch as climate, crime rate, andrecreational opportunities when lookingfor a new state to call home, but howmany consider a state's tax structure?

There are seven states that do nottax personal income: Alaska, Florida,Nevada, South Dakota, Texas,Washington, and Wyoming. NewHampshire and Tennessee only taxdividends and interest income exceedinga certain limit. While the presenceof state income tax is a major consideration,its absence does not necessarilymake a particular location a retirementhaven. Higher sales and propertytaxes can often negate the benefits ofnot paying a state income tax.

Currently, 26 of the 41 states that dotax income do not tax Social Securitybenefits. Only Illinois, Mississippi, andPennsylvania fully exempt all publicand private pensions from taxation,and seven states—Alabama, Hawaii,Kansas, Louisiana, Massachusetts,Michigan, and New York—fully exemptfederal civil service, military, andstate and local government pensionpayments from taxes.

Wall Street Journal

The considersCalifornia, Montana, Nebraska, NewMexico, North Dakota, and Vermontthe roughest on retirees because eachhas a relatively high top tax bracket andfully taxes most retirement income.

Wall Street Journal

IRA minimum distributions are subjectto both federal and state incometaxes. The says thatmoving to a state with no income taxcould save you money. If you live in astate that has a 5% income tax rate, youwill owe approximately $25,000 foreach $500,000 withdrawn from yourIRA. Paying a large amount of stateand/or local income tax could also subjectyou to the alternative minimum tax.

Once you relocate, you need notworry about your former state trackingyou down with a tax bill, thanks to a1996 federal law. Suppose you lived andworked your entire career in New YorkCity, contributing hundreds of thousandsof dollars to a Keogh, SEP, orprofit-sharing plan while taking stateand federal tax deductions. When youretire, you roll the plan balance into anIRA. At age 70, you decide to move toFlorida, which has no personal incometax. Once you move, you can withdrawmoney from your IRA and payno tax to New York.

However, if you do move, make certainyour move is official. Change yourdriver's license, vehicle registration,voter's registration, and bank accountsto your new state. Be sure to live morethan half the year in your new state ifyou intend to maintain dual residences.