Retirement income from defined benefit plans catches a break in these states.
| Retirement income comes in all forms, and pension payouts are just one of them. To the federal government, most pension payouts are fully taxable as income. To the 50 states and the District of Columbia, the tax picture for pension payouts is a bit more complicated.
A patchwork of tax rules
Eight states – Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming – don't tax income at all. A ninth state, New Hampshire, only taxes capital gains and dividend income. And six states – Alabama, Illinois, Iowa, Hawaii, Mississippi and Pennsylvania – exclude pension income from state taxes.
If you don't live in those 15 states, you still may avoid paying taxes on all or some of your pension. According to Wolters Kluwer, a tax publishing company, 26 states tax some, but not all, of retirement or pension income. Typically, these states tax pension income only above a certain level of adjusted gross income. For example, Missouri subtracts $6,000 of private pension income from your adjusted gross income (AGI) if you are married filing jointly and your AGI is less than $32,000. Single filers with AGI of $25,000 or less also get the $6,000 subtraction. Public pensions are exempt from state tax.
A Patchwork Of Retirement Income
Pensions pay out a defined amount each month until an employee dies, which is why they are called defined benefit plans. Your payout typically depends on your salary over time, and how long you worked with the company. Pensions are becoming increasingly rare among private employers, however: Only 15 percent of private companies offered a pension plan to new hires in 2019, down from 59 percent in 1998.
Increasingly, Americans have had to rely on defined contribution plans, such as 401(k) plans, for retirement income. The payout from these plans depends on how much you (and often your employer) contribute, as well as the investment returns in the plan. In most defined contribution plans, distributions are taxed as ordinary income by the federal government, but state taxation varies. Of the 15 states that won't tax your pension, two states – Alabama and Hawaii – will tax your income from defined contribution plans such as 401(k)s.
Finally, there's Social Security income. The federal government can tax some Social Security benefits, depending on your income. You'll be taxed on:
- up to 50 percent of your benefits if your income is $25,000 to $34,000 for an individual or $32,000 to $44,000 for a married couple filing jointly.
- up to 85 percent of your benefits if your income is more than $34,000 (individual) or $44,000 (couple).
And 11 states — Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia — can tax all or part of your Social Security benefits.
Taxes Aren't Everything
States need money to pay for roads, services and education, and if they don't tax retirement benefits, they will find the money elsewhere — typically in property or sales taxes. And there are other considerations, too. The Tax Foundation, a nonpartisan think tank, rates Alaska as one of the most tax-friendly states to live in. Your decision to move to Alaska should also take into account your fondness for cold winters and bears.
Source: John Waggoner, AARP, August 7, 2023