Legal and Tax Considerations for Retirees Choosing a Retirement Destination

There are quite a few factors to consider for seniors facing retirement in the United States.1 While retirees will still owe federal taxes regardless of where they choose to retire, various states’ tax laws will often play at least some role in weighing a retirement destination. For example, some states are especially tough on retirees since, in addition to levying tax on most pensions and other retirement income, they also have high top tax brackets. “Economic security of seniors is being challenged by dramatically increasing expenses, such as for healthcare and housing. These fundamental changes in the lives of older Americans make it not only more difficult for seniors to enter retirement with economic security but also to remain economically secure throughout retirement.” 2

            Since at the time of retirement retirees’ income will most likely be fixed, it is important to take into account various factors which may affect a person’s retirement situation. In fact, depending upon their state of residence, retirees may end up paying not just state taxes, but also “sales taxes, excise taxes, license taxes, income taxes, intangible taxes, and property taxes.”3 Also, it is important to consider potential state specific laws regarding estate taxes and inheritance taxes which come into play after death

            According to Commerce Clearing House (“CCH”), a Wolters Kluwer business and a leading provider of customer-focused tax, accounting and audit information, while property prices have declined over recent years, this trend does not necessarily apply to property taxes, which may have remained steady or even increased.4 Some states authorize municipalities to provide property tax relief (pertinent to renters in some jurisdictions) to seniors in the form of “tax exemption[s], credit[s], abatement[s], tax deferral[s], refund[s] or other benefits . . . [t]he benefits typically have qualifying restrictions that include age and income of the beneficiary.”5

            Furthermore, tax treatment of retirement benefits varies widely across the states. While Illinois, Mississippi and Pennsylvania exempt pension income entirely for qualified individuals, twenty-one other states exempt only a portion of pension income, and fifteen other states generally tax pension income in its entirety.6Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia impose a tax on Social Security income, at the state level, in addition to the Federal level.7 In addition to state taxes on retirement benefits, seniors should also consider state income and sales tax rates; in the case of an individual who is planning to work part-time during retirement to supplement his retirement package, such rates can have a real effect on choosing a retirement location. Since some retirees will be facing federal income taxes in additional to plethora of other taxes, it is worthwhile to look more closely at states with lower or no income and sales tax rates as a way to hedge against the overall tax obligation.8 For example, while Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming do not tax individual income at all,9 several other states such as Arizona, New Mexico, North Dakota, Indiana and Pennsylvania had a relatively low income tax rate across all income levels.10 Also, New Hampshire and Tennessee impose income taxes only on dividends and interest.11 With respect to state and local sales taxes, only Alaska, Delaware, Montana, New Hampshire and Oregon do not impose state sales and use tax at all.12

            Finally, because state estate taxes can also influence where seniors ultimately retire (if they care what happens to their estate from a tax standpoint after they pass away), it is important to engage an attorney that can handle questions related to this complex matter, since rules vary from state to state as well as from federal estate tax laws. For example, while eighteen states impose a tax on estates valued below federal threshold for 2013, only Delaware, Hawaii and North Carolina use the federal estate tax exemption amount13 of $5.34 million per person, indexed for inflation (a tax of 40% applies to excess beyond the exemption). By contrast, “states with estate taxes typically exempt far less per estate from their tax and impose a top rate of 16%.”14

            For lawyers whose practice includes estate planning or elder law, there are numerous useful resources which they can consult in order to better assist their clients. For example, the ABA Practical Guide to Estate Planning15 discusses all aspects of the estate planning process. The Advisor’s Guide to Life Insurance16 is a useful tool for advisors in making better informed life insurance recommendations to their clients. A related helpful related book is Federal Gift, Estate, and Generation-Skipping Transfer Taxation of Life Insurance, Third Edition,17 which methodically reviews the tax implications of life insurance policies. The Irrevocable Life Insurance Trust18 will assist a practitioner to protect their clients’ estate and assets from taxation. Inherited IRAs: What Every Practitioner Must Know19serves as a guide to a practitioner to many of the retirement distribution rules that must be taken into account in order to effectively protect their clients’ retirement assets. Especially pertinent to present times, Estate Planning for Same-Sex Couples20 serves as a very important tool in providing services to the LGBT client base.

            All in all, retirees need to take into account a number of factors when assessing where they chose to retire in the United States (retirement overseas may entail additional considerations). Among other things, their retirement destination will depend on the “type and amount of income [they] will be bringing in, the value of [their] home, [their] cash-on-hand, and any specific tax issues [they] may have.21Because states need to generate revenues through different sources, even states that do not have state income taxes may nevertheless recover these lost revenues through higher sales, property and other taxes that, in the aggregate, can in fact meet or exceed the cost of a state income tax rate.22

            Given the choice to retire domestically, which states offer the best package? In the end, a great deal will depend of an individual’s financial well being and sources of income. While it would be favorable on one hand to relocate to Texas or Florida because these states do not impose state taxes, some other states may nevertheless offer very generous exemptions for Social Security benefits and other types of retirement income.

            So, at least from a basic tax consideration, Alaska, which has no state income tax, state sales tax, or inheritance tax, tops the list.23 In fact, Alaska actually gives residents money for living in the state. Nearly every Alaska resident receives a “share” of the state’s oil wealth out of the Permanent Fund Dividend. In 2013, this dividend was approximately $900.24Next is Wyoming, with no state income tax, 4% state sales tax (localities can assess 1%), and no inheritance tax. In fact, “[f]or most property, only 9.5% of market value is subject to tax.”25 Last but not least is Michigan. Michigan’s state income tax is 4.35%, its state sales tax is 6%, and it has no inheritance tax. While some other states that could qualify as a top retirement destination may have slightly more favorable numbers, what sets Michigan apart, at least to some extent, is that it does not tax “Social Security, military, federal, state- or local-government pensions.”26 What’s more, its flat-rate income tax is scheduled to gradually decline to 3.9% by 2015.27 Of course, an important point to keep in mind is that a state’s tax landscape is not static and changes in its tax laws can occur anytime. For example, Illinois has reinstated its estate tax in 2011, Delaware made permanent its previously temporary estate tax this summer, and Minnesota recently changed  its law to eliminate certain estate tax loopholes. 28

            In sum, while a state’s tax landscape is an important consideration, other factors such as cost of living, weather, recreation, employment opportunities, healthcare and people may play equal or greater role in choosing an ultimate retirement destination. Choosing to relocate in retirement is a big decision, to get a complete picture of their retirement situation, retirees should engage with an elder law attorney, an accountant, and/or a financial advisor when assessing their retirement situation and potential domestic destination.