We all want out retirement savings to last as long as possible and reducing your tax bill in retirement can be a great way to stretch every dollar.
One of the biggest factors that will determine your tax bill in retirement is where you live and surprisingly, there are significant tax differences depending on which state you decide to retire in.
But we have to mention that states have 3 main types of taxes that they levy. Income tax, sales tax, and property tax. You will want to pay attention to all 3 before you make a decision on where to live.
Your Federal Retirement Income
Your federal retirement income is often made up of 3 things. Your pension, Social Security, and distributions from retirement accounts (your TSP, IRAs, etc.).
On the federal level, all 3 of these income sources can be taxable. At the state level, it will vary state to state.
Social Security
Many people I talk to are surprised to find out that Social Security benefits can be taxable at all. And because most feds have a healthy pension and TSP come retirement time, many of them will have up to 85% of their benefits taxed on the federal level.
The good news however, is that most states don’t tax your Social Security benefits. There are just 13 states that do and they are the following: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia.
Each state has their own criteria and structure for this taxation.
Your Federal Pension
On the federal level, the majority of your pension will be taxable. They calculate the taxable amount by looking at how much you contributed into the system over your career and they spread that over your life expectancy in retirement. The portion of your pension that they calculate to be your contributions will be tax free with the vast majority (generally 90%+) being taxable.
But again, there are many states (14 to be exact) that do not tax pension income at all. Here they are: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming New Hampshire, Alabama, Illinois, Hawaii, Mississippi, and Pennsylvania.
Some of these states don’t have an income tax at all while others just exclude pension income from their income tax.
Your TSP Distributions
As the Roth TSP becomes more and more popular, more federal employees will be able to enjoy at least some tax free income in retirement. But as of today, the vast majority of federal employees’ savings are in the traditional TSP which means that it will at least be subject to federal taxes when it comes out.
And while most states tax TSP distributions as well, these 12 don’t: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, Wyoming, Illinois, Mississippi and Pennsylvania.
The Best States to Retire as Federal Employees
As you probably noticed, there are many states that don’t tax any of the 3 main sources of retirement income for federal employees which can go a long way in helping money stretch as long as possible.
But as I mentioned before, a state has 3 common ways to levy tax. Income tax, sales tax, and property tax. And often when a state doesn’t have an income tax then they have to make up for it with higher than average sales or property taxes. On top of that many cities have substantial taxes of their own.
And while there is no perfect place to retire, moving to lower tax states can be a great way to stretch your savings for as long as possible.
