How State and Local Taxes Shape Your Retirement

Variations in key taxes create big incentives to match your lifestyle with the most favorable tax mix

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Federal taxes on income, investment gains, and Social Security benefits dominate most discussions of retiree tax issues. But while we may complain or even seek to change these taxes, they tend to affect us equally regardless of where we make our retirement home.

State and local taxes, however, are a much different matter. There are big differences in these taxes among the states. U.S. News drew upon state and local tax information from the Federation of Tax Administrators, the Tax Foundation, the National Conference of State Legislatures, and the Council of State Governments. The most current available information is presented but rates can change, so it's wise to contact taxing authorities before making decisions.

New Jersey is the leading "taxaholic" state. Its citizens paid 12.2 percent of their incomes in various state and local taxes and fees in 2009. Other top taxing states were New York (12.1 percent), Connecticut (12 percent), Wisconsin (11 percent), and Rhode Island (10.7 percent). Alaska, which relies on enormous oil royalties, is home to the nation's least-taxed residents in terms of what they pay in state and local taxes. It collected only 6.3 percent of average per-capita incomes. Nevada, which is also something of a special case because of its gambling revenues, came in second at 7.5 percent. The other lowest-taxing states were South Dakota and Tennessee (both 7.6 percent), and Wyoming (7.8 percent).

Looking at the total average hit for state and local taxes is only a starting place. Even states with high overall tax burdens can be attractive, depending on your particular income and lifestyle preferences, as well as your healthcare situation. Looking at specific taxes is thus the best way to determine how much you will pay in state and local taxes during your retirement years. In some cases, this research may even determine where and how you want to live.

Here are thumbnails of the states with the best and worst records for specific state and local taxes:

1. Property tax. Property taxes are the most important source of state and local tax revenue, generating a third of all tax collections in 2009. This compares with 23 percent for general sales taxes, 21 percent for individual income taxes, and about 4 percent for corporate income taxes. Because property taxes are set by local governments, it's hard to provide any simple guidance to low-tax areas. Also, localities frequently offer property-tax relief to seniors. Overall, states that relied the most on property tax revenues in 2009 were New Hampshire (64.4 percent of total state and local tax revenues), New Jersey (45.7 percent), Rhode Island (44.6 percent), Vermont (44.2 percent), and Florida (43.1 percent). States relying the least on property taxes were Arkansas (16.8 percent), New Mexico (17.5 percent), Delaware (17.6 percent), Alabama, and Louisiana (both 17.9 percent).

2. Sales tax. The nation's steepest sales taxes in 2010 were in California (8.25 percent), plus Indiana, Mississippi, New Jersey, Rhode Island, and Tennessee (each 7 percent). Many states exempt basic food products or tax them at lower rates. Alaska, Delaware, Montana, New Hampshire, and Oregon have no sales tax.

3. State income tax. The bracketology of state income taxes rivals the NCAA basketball tournament. High tax brackets are an important ranking criterion, but you also need to look at the incomes that trigger each bracket's rate plus the personal exemptions used in each state. States with the highest tax rates for wealthier residents in 2012 are Hawaii (11 percent on incomes above $200,000); California (10.3 percent on incomes above $1 million), Oregon (9.9 percent on incomes above $125,000), New Jersey (8.97 percent on incomes above $500,000), the District of Columbia (8.95 percent on incomes above $350,000), and Vermont (8.95 percent on incomes above $379,150). Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state income taxes. New Hampshire and Tennessee tax only interest and dividend income.

That's not the entire story, however, because nearly 5,000 localities in 17 states have separate local income taxes on their residents. New York City, for example, charged income taxes of up to 3.876 percent in 2011. Added to the state's top income tax bracket of 8.82 percent, total state and local income taxes for some New Yorkers are the nation's highest.

4. Gasoline tax. States collecting the most money per gallon of gas in 2012 are New York (49 cents), California and Connecticut (each 48.6 cents), Hawaii (47.1 cents), and Michigan (39.4 cents). The lowest gas-tax states are Alaska (8 cents), Wyoming (14 cents), New Jersey (14.5 cents), South Carolina (16.8 cents), and Oklahoma (17 cents).

5. Driving tolls. Delaware may be a small state, but it charges a lot for the privilege of driving through it. In 2005 (the most recent numbers we could find), the state's per-capita road tolls were $221.28, far surpassing the other high-toll states of New Jersey ($125.77), New York ($85.90), Alaska ($76.28), and Massachusetts ($57.06). Twenty states really put the "free" in freedom of the road and charged no tolls in 2005: Alabama, Arizona, Arkansas, the District of Columbia, Hawaii, Idaho, Iowa, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, Oregon, South Dakota, Tennessee, Utah, Vermont, Wisconsin, and Wyoming.

6. Alcohol and tobacco. States that produce these products tend to have the friendliest taxes on them. Some states that limit sales to state-run stores do not break down their taxes in ways that permit direct comparisons. There are separate taxes on beer, wine, and distilled spirits.

Beer (per gallon): Highest (in 2010): Alabama ($1.05), Alaska ($1.07), Georgia ($1.01), North Carolina (99.7 cents), and Hawaii (93 cents). Lowest: Missouri and Wisconsin (each 6 cents), Kentucky and Pennsylvania (each 8 cents), and Maryland and the District of Columbia (each 9 cents).

Wine (per gallon): Highest (in 2010): Alaska ($2.50), North Carolina ($2.34), Florida ($2.25), and Alabama and New Mexico (each $1.70). Lowest: Wyoming (1.9 cents), Louisiana (11 cents), California (20 cents), Texas (20.4 cents), and Wisconsin (25 cents).

Distilled Spirits (per gallon): States with the highest taxes tend to be those that limit sales to state-run outlets. Highest (in 2010): Washington ($26.45), Oregon (24.63), Virginia ($20.13), Alabama ($18.78), and North Carolina ($13.39). Lowest: Wyoming (the implied excise tax from state-controlled stores is less than zero), Maryland and the District of Columbia (each $1.50), Missouri ($2), and Colorado ($2.28).

Cigarettes: By far, the steepest taxes in 2012 are in New York ($4.35 a pack and $5.85 in New York City), Rhode Island ($3.46), Connecticut ($3.40), Hawaii ($3.20), and Washington ($3.02½). Virginia has the nation's lowest cigarette taxes (30 cents a pack), although localities may impose additional taxes ranging from 2 to 15 cents a pack. It is followed by Louisiana (36 cents), Georgia (37 cents), Alabama (42½ cents), and North Dakota (44 cents).

7. Lottery tax rates. U.S. News looked at what percentage of state lottery revenues were kept by each state and how much was returned as lottery winnings. States that kept the most money in 2008 were Oregon (120 percent but, due to reporting of video-lottery terminal sales, its results are not comparable to other states), West Virginia (66.3 percent, but it also has comparison issues due to video-lottery terminal sales), Louisiana (54.5 percent), Oklahoma (54.2 percent), and California (54 percent). States with the lowest revenue retention: Rhode Island (17 percent), South Dakota (21 percent), Massachusetts (24 percent), Maine (27.6 percent), and Vermont (28.5 percent).

8. Corporate income taxes. Business taxes can have a big affect on retirement living decisions. As with personal income taxes, rates need to be aligned with the dollar amounts of their respective tax brackets to produce apples-to-apples comparisons. For example, a 10 percent top tax rate on income above $1 million may not be as meaningful as an 8 percent rate on income above $100,000. Also, some states have business receipts taxes and other business taxes.

Five states have relatively high tax rates in 2012 on all taxable corporate income: Pennsylvania (9.99 percent), the District of Columbia (9.975 percent), Minnesota (9.8 percent), Illinois (9.5 percent), and Connecticut (9 percent). Iowa has a top 12 percent bracket on income above $250,000, and Alaska has a top bracket of 9.4 percent on income above $90,000. Nevada, South Dakota, and Wyoming do not have corporate income taxes. Ohio, Texas, and Washington do not have a corporate income tax, but do have a gross receipts tax. States with a low top bracket for corporate income include Colorado (4.63 percent on all corporate income), Mississippi (5 percent on income above $10,000), and South Carolina and Utah (5 percent on all income).

9. Pension and Social Security income taxes. Most states provide some income-tax relief for older residents who receive public and private retirement income. Precise rules differ widely and may make a big difference in your after-tax income. Simple rankings of high-tax and low-tax states aren't sufficient guides. Last year, the National Conference of State Legislatures produced a review of pension taxation as of 2010 that's worth careful study by anyone wanting to know these details.

Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state income taxes, so of course do not tax retirement income, either. New Hampshire and Tennessee tax only interest and dividend income. Among the other states with a personal income tax, five states provide no special pension income relief: California, Nebraska, North Dakota, Rhode Island, and Vermont. However, California provides full tax relief on Social Security income, while the other four use the federal tax rules in taxing Social Security. Eleven states subject to at least some Social Security income to taxation: Colorado, Connecticut, Iowa, Kansas, Kentucky, Minnesota, Missouri, Montana, New Mexico, Utah, and West Virginia. There may be age and income provisions for relief from such taxes.

10. Estate and inheritance taxes. In 2012, only 18 jurisdictions have taxes on estates: Connecticut, Delaware, the District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Ohio (its tax is being repealed in 2013), Oregon, Rhode Island, Tennessee, Vermont and Washington. Washington has the highest maximum rate of 19 percent and an exclusion of $2 million. Fourteen other areas have the same tax brackets, ranging from 0.8 percent to 16 percent, with exclusions ranging from $1 million to $5 million.

Twitter: @PhilMoeller