Taxes are a big consideration when it comes to deciding where to live during retirement, and according to a recent report from Kiplinger, “States That Tax Your Federal Government Pension the Most,” the difference in how federal government pensions are taxed—or not taxed, as the case may be—varies considerably. Some states treat this kind of income very differently than private pensions.
When you look at a retirement destination, you might consider avoiding states that tax federal government pensions. It could save a federal retiree many thousands of dollars in state taxes every year throughout retirement.
There are some states that will tax all pension income, such as California, Connecticut, Nebraska, North Dakota and Vermont—as well as the District of Columbia. All of these states, except North Dakota, make Kiplinger’s list of “Least Tax-Friendly States for Retirees.”
Wisconsin is also tough on retiree taxes, but does make exceptions for the commissioned corps of the National Oceanic and Atmospheric Administration (NOAA) and the Public Health Service (such as the Surgeon General). Their pensions are exempt along with those of military veterans.
Those collecting federal pensions need to consider four other states: Arizona, Montana, Ohio, and Utah. Like many states, these four states exempt some retirement income from taxation, including income from federal sources. But the difference is that their exemptions are quite limited compared with the average.
For example, in Montana, only $4,110 of income can be exempt, and the retiree’s adjusted federal gross income (AGI) must be less than $34,260 to qualify.
In Arizona, the exemption is even lower at $2,500, but it’s not limited by income.
Ohio offers a tax credit. However, the most you can deduct is $250. Utah is a tax-credit state. Their maximum credit is $450. Ohio and Utah limit this credit based on income.
Another thing to keep in mind: in some states, even those who are not great about traditional federal pensions, railroad retirement benefits and military pensions receive special exemptions.
This should be part of a conversation with your estate planning attorney, when looking into retirement and estate tax responsibilities and how your state or a state you are considering relocating to, treats different kinds of pensions and assets.
Reference: Kiplinger (May 16, 2017) “States That Tax Your Federal Government Pension the Most”