The Hidden Taxes In Tax-Free States
Moving to an income tax-free state in retirement may not lead to the tremendous savings retirees expect. The question to ask yourself when considering a new location is “How is this government funding itself?” Oftentimes, the answer in states like Texas is property taxes. For example, in several counties in Texas, the property tax rate is over 2%, whereas it might be .5% to 1% in states with income taxes.
Let’s say Jim and Sally have an annual household income of $100,000 in retirement. They are currently paying $5,000 (5% rate) in state income taxes and $2,500 in property taxes on their $500,000 home (.5% rate). They decide to move to Texas and buy a similar $500,000 home. They now have $0 in state income taxes (0% rate) but pay $10,000 in property taxes (2% rate). From a tax perspective, they would have been better off staying put.
The way in which a local government funds itself may vary greatly. It may be higher property taxes or sales taxes. In addition, states without income taxes may have other costs that need to be factored in, like hurricane or flood insurance in some areas of Florida and Texas that can cost north of $5,000/year!
Before making a decision to move, it’s good to pause and crunch the numbers. In some areas, the tax code may be tilted toward retirees. For example, a state that levies an income tax but Social Security, pensions, and even IRA withdrawals are excluded – for example, Illinois or Mississippi.
Source: AARP
States like these are golden opportunities for retirees because they can take advantage of the lower property and sales taxes and also shield the majority of their retirement income from state taxes.
However, state taxes should play a minimal role in your decision since the costs are generally going to be 5% or less of your total income. The most important decision is to be somewhere that you enjoy and if there are added tax benefits, that’s a bonus!
Happy Planning,
Alex
This blog post is not advice. Please read disclaimers.