Taxes are inevitable in retirement just like they are during your working years.
Some government entities, however, are easier on retirees than others. When you're thinking about retirement, it's a good idea to consider the tax liability of your state when estimating your expenses. (For related reading, see: Top Tips for a Tax-Conscious Retirement.)
Kiplinger, in 2014, released some analysis of state taxes. One of its most shocking statements comes at the beginning of the article regarding some of the states it analyzed: "Five of them treat Social Security benefits just like Uncle Sam — taxing up to 85%. Exemptions for other types of retirement income are limited or nonexistent."
If that doesn't grab your attention, nothing will. Don't make the mistake of ignoring state taxes.
Least Friendly Tax States
Here are some of the least-friendly tax states for retirees according to Kiplinger:
Rhode Island: This state taxes Social Security benefits up to 85%. With so many Social Security recipients depending on the program for life-sustaining income, this is one state that's worth avoiding in retirement. Also noted was the fact that property taxes are relatively high compared to other states.
Vermont: Vermont really isn't a close second — it's pretty much tied with Rhode Island as being one of the least friendly tax states for retirement. Social Security benefits take a hit in Vermont, being taxed up to 85%. But it doesn't stop there. Local jurisdictions may add 1% to the state sales tax. While there are certain exceptions, you will essentially pay 9% tax on restaurant meals and prepared foods in Vermont. (For more, see: Top Tips for Minimizing Taxes on Social Security.)
Connecticut: Kiplinger describes Connecticut as a "tax nightmare for many retirees." And for good reason. Real estate taxes in Connecticut are the tenth highest in the country, as reported by the Tax Foundation. While half of military retirement pay is excluded from taxes, you can forget about exemptions for other pensions or income in retirement.
Consider All Tax Implications
If you live in any one of these three states or any of the others in Kiplinger article and you're nearing or in retirement, you might want to consider what other states offer in terms of lower taxes for retirees. And remember not to solely focus on one factor alone in considering where to spend your retirement.
Retirees, in general, usually have low earned income. While that in itself doesn't give a retiree much reason to stay away from states with high income taxes, a retiree is certainly a consumer, which is why it's critical to focus on staying away from states with high sales taxes or property taxes.
Oregon has no sales tax whatsoever, which may make it a decent retirement destination. However, it's also important to consider the state's property taxes.
Think through your situation; consider how your particular expenses might be taxed in a certain state. Consider how your property will be taxed. Find the best cities for retirees and perhaps weigh the decision to move to one of them. (For related reading, see: Best Strategies for Managing Taxes on Distributions.)
While it's important to consider tax implications in retirement, it's certainly not the only factor to consider. Retirees, being out of the workforce, need to discover and maintain social interaction outside of the office. As a retiree, you should consider where your family and friends live. How often will you be able to visit with them? Would they be a good support in a time of need? Don't underestimate the value of having relationships nearby. Maintaining close relationships is certainly worth paying a little more in taxes.
The Bottom Line
There are several ways in which retirees in particular get struck with having to pay high tax rates. By understanding and avoiding these situations, you can save money and live more comfortably in retirement. Try to take a holistic approach to retirement planning. Don't fall into the trap of only considering taxes and their impact on your post-working income. Consider the quality of your retirement, too. (For related reading, see: Yes, You Can Manage Your Own Retirement!)