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Should a State’s Tax Code Determine Where I Retire?

Should a State’s Tax Code Determine Where I Retire?

Tax liability is, for many, a key criterion to consider when deciding where to retire. California is a high-tax state, and many retirees are understandably looking to lower their tax burden when they no longer have a steady stream of earned income to buffer that expense. We advise caution here. While one tax type, such as income tax, is low in a given state, other taxes, such as sales taxes and property taxes, may be higher, so moving to that state will not necessarily lessen your tax burden.

While there are nine states across the country that are currently “income tax free”, they may not provide the free lunch you think they do. Before examining the potential tax benefits offered by those states, let’s start with California, which is home for many Sand Hill clients. Here is how the Golden State stacks up at present: 

  • California has a high state income tax, with the highest rate at 13.5%.
  • Required Minimum Distributions from retirement accounts such as IRAs, 401(k)s, 403(b)s, and pensions are taxed as ordinary income.
  • California has high property taxes in dollar terms (about 1% due to Prop 13 passed in 1978).
  • State and Local Tax (SALT) deductions are capped at $10,000, which is an unusually low bar for a high state income tax / high property value state.

California is indeed on the high end of state tax liabilities, from a high state income tax rate to a high property tax burden. However, tax liability can be complicated when total liability/situational factors are considered. Below are some comments on states that are on the radar of many Californians looking to lower their tax burden, as of the date of publication.

Oregon – “There is no sales tax.”
While property values may be lower in Oregon, the property tax rate is higher. And, similar to California, Oregon has a high state income tax rate, topping off at 10.8% for the highest tax bracket. Additionally noteworthy: Oregon is one of the few states with a state estate tax of between 10% and 16% for estates greater than $1 million. 

Washington – “There is no income tax.”
Washington is one of the states with no income tax. There is also no federal tax on Social Security or pensions for Washington residents, but Washington’s property tax burden is similar to California’s. And in a new development that has upended some retirees’ plans to escape taxes, beginning January 1, 2022, Washington instituted a 7% capital gains tax on long-term capital gains above $250,000. Additionally, Washington’s state sales tax burden is 9th highest in the U.S. 

Idaho – “Taxes are low.”
While there is a state income tax in Idaho, the top effective state/local rate is 10.7%.  Additionally, there is a sales tax of 6%, and retirement benefits like Social Security and pensions are all taxed at ordinary income rates. Another important observation is that property taxes have skyrocketed in recent years in tandem with increased property values because there is no Prop 13 to cap them. 

According to WalletHub’s study from March 2022 that ranks property, income, and sales tax by state, Arizona is 29th on the list, similar to Oregon and Washington. Nevada is 33rd, Montana is 43rd, and Wyoming is 47th. For comparison, New York is 1st on the list and California is 9th

For those leaving California to avoid taxes, it is important that you don’t underestimate how far the Franchise Tax Board (FTB) will go to recover taxes owed on income generated in California, be it through a liquidity event or any other earnings. The FTB will expect its share, so be sure to understand your specific tax situation before you start house shopping for your retirement home in another state. And while it may be possible to save on taxes in retirement by leaving California, our best advice is to have other reasons for moving than just tax liability when you choose your dream retirement location.  Please contact your Wealth Manager to discuss further. 

Sources: Internal Revenue Service, Motley Fool, Kiplinger’s, WalletHub, Tax Foundation

Articles and Commentary

Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.

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