States That Don’t Tax Retirement Income

Retirement income comes from retirement plans or profit-sharing plans, traditional or Roth IRAs, Social Security, pensions, annuities and insurance contracts. This type of income may be fully or partially taxed depending on state tax rules. Each state has different rules regarding the tax treatment of retirement income, so it is important for retirees to understand their state tax rules.

When you receive distributions or withdrawals from tax-deferred retirement accounts, such as 401(k)s, 403(b)s, traditional IRAs, annuities, pensions, and Social Security benefits, some or all of the income may be taxed. That is, unless you live in a state that does not have income tax.

Annuity income may also be taxed if the income is from a tax-deferred annuity. Alternatively, since Roth IRAs are funded with after-tax money, the income is not taxed upon withdrawal. The taxation of military retirement income is dependent upon the state, in which some states don’t tax.

State income tax is a tax the state government imposes on the personal income of its residents and non-residents who have income sources from that state. Most states levy this tax on taxpayers earned and unearned income sources as a means of funding state government revenue.

However, some states are more generous than others and have no tax on income at all. Each state has different tax rules and rates on which they tax income, some impose a flat tax on all income or a progressive tax based on a taxpayers level of income. When planning for retirement, it’s important to consider a state’s taxation on income as this affects your future budget and financial resources.

Social Security benefits are generally taxable at the federal level up to 85%, depending on how much total income sources you have. In determining the amount of tax on your Social Security income, most states follow federal rules or have their own tax calculations.

However, some states exempt all Social Security benefits from state tax or will only partially tax benefits. Since there’s a possibility you may be taxed on the federal end when you start collecting Social Security benefits, its best to consider states that are more lenient on Social Security to help keep money in your pockets.

In 38 states, Social Security benefits are exempt from being taxed.

Like any tax-deferred investment, you pay income tax on the withdrawals, including those from pensions. Taxes on pension income varies by state — some states don’t tax pension income while others do. 

Income received as distributions or withdrawals from retirement accounts, such as 401(k), 403(b), traditional IRA, and tax-deferred annuities is generally subject to tax. A Roth IRA or Roth 401(k), however, is not subject to tax upon withdrawal since the contributions were made with after-tax dollars, assuming the withdrawal meets IRS requirements. Some states do not levy a tax on any retirement accounts.

Generally, you pay taxes on a tax-deferred Thrift Savings Plan (TSP), which allows federal employees to save part of their income for retirement and take distributions from the account as regular income.

The distributions from a TSP account are taxed at your ordinary income tax rate. When planning for retirement, its best to consider the lifestyle you want to live and base the money you take from your TSP on your income needs to accomplish those goals.

Some states levy tax on the transfer of money or property at death through inheritance and estate tax. At the federal level, estate tax is imposed on assets over $12.92 million in 2023, however there’s no federal inheritance tax.

States impose inheritance tax as a percentage on the value of the assets that the beneficiaries receive from a deceased person’s estate. Estate tax is valued based on the total of what is owned by the deceased.

At the federal level, military retirement income is generally taxed as a pension; therefore, it is included in income at the ordinary income tax rate. However, there are 28 states that are exempt from tax on military retirement income.

Some states offer partial deductions on some or all forms of retirement income. State tax may also apply to retirees of a certain age and retirement income. According to an article from Wolters Kluwer, the following states provide tax breaks to retirement plans and pensions.

But be sure to check your state’s Department of Revenue Website for the most up-to-date information.

In special cases, some states don’t follow the same rules as other states when it comes to imposing tax on retirement income. The state may tax one type of retirement income, but not the other.

There are some advantages to living in a state that doesn’t tax retirement income. For example, you’ll have more disposal income at your fingertips to use for other expenses such as travel, medical, emergencies and to pursue your hobbies.

Another benefit is you will have the ability to stretch your retirement savings to ensure a sense of security for a longer time.

Last, there’s less stress about your finances, which better improves your standard of living and peace of mind.

As there are benefits to living in a state that doesn’t tax retirement income, there are also disadvantages.

For one, most states that don’t tax retirement income often offset this with higher sales taxes and property taxes.

In addition, there’s usually lower state funding for schools and infrastructure due to retirement income not being a source of state tax revenue.

Finally, there’s usually a lack of state services and programs due to funding availability.

Before deciding where to retire, it’s important to research state taxes to understand the implications of how a state taxes your income, since this impacts your future finances. You may already be subject to paying taxes on your income to the federal government, but at least you can ease the burden of your income being taxed by the state government with careful, strategic retirement planning.