Personal Finance

Least tax-friendly states for retirees

Shelly Gigante, Special to CNBC.com

Retirees & Taxes

West Coast Surfer | Getty Images

Forget what you know about withdrawal rates. The key to making your nest egg last is to spend less money than you earn.

Due to state tax law differences, however, you'll soon learn that where you live during retirement largely dictates what you spend.

Some states, such as Minnesota and Vermont, impose a hefty tax on retirement income, while California's top income tax rate is a budget busting 13.3 percent. Others, including New Jersey, have the highest property tax rate in the nation, while 14 states tax Social Security benefits either in part or in full. They are: Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia. (Not all, though, made our list of least tax friendly states for retirees.)

Also, the sheer size of the aging baby boomer population has encouraged most states to consider more tax-favorable legislation for seniors, said Kathleen Thies, state tax analyst for CCH tax services firm in Riverwoods, Ill. And some relief programs have already been enacted.

But due to their combination of taxes on ordinary income, pensions, real estate, inherited property and estates, the following 10 states can best be described as hostile territory for retirees.

The list was culled with data collected from CCH, the Tax Foundation, state revenue departments, retirementliving.com and the Federation of Tax Administrators. (Property tax rates, compiled by the Tax Foundation using Census Bureau data, are through calendar year 2011 and reflect the mean property tax as a percentage of mean home value.)

And because tax laws impact retirees differently, depending on their financial circumstances, we did not attempt to rank each state in terms of tax friendliness—or lack thereof. The states are instead presented in alphabetical order.

By Shelly K. Schwartz, Special to CNBC.com
Posted 22 Aug. 2013

California

Los Angeles
David Sucsy | E+ | Getty Images

State income tax: 1% - 13.3%
State sales tax: 7.5% (combined state, local rate)
Mean property tax rate as a percentage of mean home value: 0.8%
Property tax ranking: 33
Estate tax: Limited to the federal estate tax collection rate
Inheritance tax: None

The sunny skies of California may be a playground for movie stars and millionaires, but retired residents should take their money and run.

The so-called Golden State, where fortune cookies, blue jeans and Apple computers were invented, levies one of the nation's highest personal income tax rates. Its tax exemption for Social Security benefits is little comfort, given that most other retirement income gets taxed in full.

And property taxes are assessed at 100 percent of the home's value, up to a maximum of 1 percent of the home's cash value. That can deliver a serious dent to your standard of living. Median home prices for new and existing houses and condominiums reached $340,000, with high real estate prices in cities including San Francisco, Los Angeles and San Diego.

Connecticut

Homes in Connecticut
Tina Buckman | Photolibrary | Getty Images

State income tax: 3% - 6.7%
State sales tax: 6.3%
Mean property tax rate as a percentage of mean home value: 1.49%
Property tax ranking: 10
Estate tax: 7.2% - 12%, exemption amount $2 million
Inheritance tax: None

This commuter haven for New York's business elite may be famous for Yale University and its maritime past, but the Constitution State doesn't cut seniors any slack—especially those of means.

Indeed, Connecticut levies a progressive estate tax of up to 12 percent beyond the $2 million exemption. It also taxes pension benefits, and is one of only 14 states that tax Social Security income. Seniors looking to stretch their hard-earned savings further might do well to cast a wider net.

Iowa

Des Moines, Iowa
Jeremy Woodhouse | Getty Images

State income tax: 0.36% - 8.98%
State sales tax: 6% (but local taxes can add up to 2% more)
Mean property tax rate as a percentage of mean home value: 1.36%
Property tax ranking: 14
Estate tax: None
Inheritance tax: 5% - 15%, depending on amount, relationship of the heir to the decedent.

The Hawkeye State is fertile ground for farming, but it also harvests tax revenue from every available source.

Its personal income tax rate tops out at a punishing 8.98 percent, while inherited property is taxed at a maximum rate of 15 percent. Retirement income is also partially taxed, but married taxpayers age 55 or older may exclude from up to $12,000 ($6,000 for single filers) of pension benefits and other retirement pay.

Relief on some fronts, however, is already in sight. The heartland state is phasing out its tax on Social Security income by 2014, and lawmakers this year approved a property tax cut to the tune of $4.4 billion over the next 10 years—agricultural and residential property tax payers will save an estimated $500 million annually by the 10th year. On balance, however, Iowa still leaves most seniors with a bigger tax bill than they bargained for.

Maine

Woman canoeing in Baxter State Park, Kidney Pond, Maine
George Ostertag | Superstock | Getty Images

State income tax: 2% - 8.5%
State sales tax: 5%
Mean property tax rate as a percentage of mean home value: 1.11%
Property tax ranking: 18
Estate tax: 8.0% - 12%, with a $2 million exemption
Inheritance tax: None

Maine is long on lobsters and lakefront cabins, but short on tax breaks. The Pine Tree state has a whopping 8.5 percent top marginal income tax rate, and hefty property taxes to boot.

Maine also hits wealthy retirees hard, taxing estates over $2 million up to 12 percent. Seniors may deduct up to $6,000 per taxpayer ($10,000 after 2013) of all pension annuities, and retirement plan income included as federal adjusted gross income, but that amount is reduced by any Social Security and Railroad Retirement benefits they receive.

Nebraska

Rancher in Keystone, Nebraska in truck
Kevin Horan | Stone | Getty Images

State income tax: 2.46% - 6.84%
State sales tax: 5.5%
Mean property tax rate as a percentage of mean home value: 1.72%
Property tax ranking: 6
Estate tax: None
Inheritance tax: 1% for immediate relatives with a $40,000 exemption, 13% for remote relatives with a $15,000 exemption, and 18% for all others, with a $10,000 exemption. Spouses are exempt. (This tax is levied at the county level.)

The Cornhusker State, famous for fossil beds and historic trails (Pony Express, Lewis & Clark and Oregon), not to mention Omaha Steaks, takes a piece of Social Security benefits.

Property taxes, assessed at 100 percent of actual market value, are also among the nation's highest, but homestead exemptions exist for those 65 and older based on income. Married couples with household income of up to $31,000.99, for example, are 100 percent exempt, while those making $39,301 or more get no exemption.

Correction: An earlier version of the story inaccurately said Nebraska is phasing out its inheritance tax.

New Jersey

Ditto | Getty Images

State income tax: 1.4% - 8.97%
State sales tax: 7%
Mean property tax rate as a percentage of mean home value: 1.98%
Property tax ranking: 1
Estate tax: 0.8% - 16%, with a $675,000 exemption
Inheritance tax: 0% - 16%, applies only to estates over $1 million

With many of its most populous suburbs in the shadow of Manhattan or Philadelphia, New Jersey offers aging adults proximity to urban culture and fine dining—if they can afford it.

The Garden State has the nation's highest mean property tax rate and a maximum state income tax rate of 8.97 percent. It also levies a sizable tax on estates and inherited property. Social Security benefits are not taxed on the state level, but all forms of retirement income are included on state tax return as income.

A "Pension Exclusion" does help, however, allowing retirees 62 or older with income below $100,000 to exclude up to $20,000 per year for married joint filers in taxable pensions, annuities and IRA distributions. The limit for single taxpayers is $15,000.

New York

New York City
Sylvain Sonnet | Photodisc | Getty Images

State income tax: 4% - 8.82% (not including local income tax)
State sales tax: 4%
Mean property tax rate as a percentage of mean home value: 1.38%
Property tax ranking: 13
Estate tax: 0.8% - 16%, $1 million exemption
Inheritance tax: None

It's no secret that New York City is a pricey place to live. But the rest of the state also packs a wallop on your wallet.

The Empire State has the highest individual income tax collections per capita, at $1,865, according to the Tax Foundation. New York's income tax rate is already steep, but the Tax Foundation notes many taxpayers with income above $100,000 pay their top tax rate on all of their income, not just the amount above the bracket threshold. Social Security benefits are exempt.

While property taxes are high, seniors in some localities may be able to reduce the assessed value of their home for tax purposes by up to 50 percent. Income restrictions apply.

Minnesota

Ryan/Beyer | Photographer's Choice | Getty Images

State income tax: 5.35% - 7.85%
State sales tax: 6.875%
Mean property tax rate as a percentage of mean home value: 1.09%
Property tax ranking: 19
Estate tax: 0.8% - 16%, with $1 million exemption
Inheritance tax: None

The North Star State where ice hockey reigns and moose roam free gives retired residents a chilly reception.

Minnesota imposes a hefty personal income tax, sale tax (though food, clothing and medication is exempt) and property tax. It also taxes retirement income, including Social Security benefits and pensions, and wants a piece of your estate.

The state does offer a break to those 65 and older with household incomes of $60,000 or less, with a property tax deferral program that limits the amount of property tax they pay to 3 percent of total household income.

Rhode Island

Providence, Rhode Island
Dens Jr. Tangney | E+ | Getty Images

State income tax: 3.75% - 5.99%
State sales tax: 7%
Mean property tax rate as a percentage of mean home value: 1.41%
Property tax ranking: 11
Estate tax: 0.8%-16%, with a $910,725 exemption
Inheritance tax: None

What it lacks in size, Rhode Island more than makes up for in tax collections.

The quaint coastal state taxes most forms of retirement income in full, including Social Security, pensions and capital gains income. Real estate, personal income, and consumer goods are taxed at a higher than average rate, which cuts into your savings faster than you can say steamed clams.

Vermont

Rural Vermont
Ron and Patty Thomas Photography | E+ | Getty Images

State income tax: 3.55% - 8.95%
State sales tax: 6%
Mean property tax rate as a percentage of mean home value: 1.59%
Property tax ranking: 8
Estate tax: 0.8% - 16%, with $2.75 million exemption
Inheritance tax: None

Beloved by skiers, leaf peepers, and Ben & Jerry's ice cream aficionados, the Green Mountain State gets extra points for New England charm. But that hardly negates the impact of a tough tax climate.

There are no exemptions for most retirement income, and property taxes here are the eighth-highest in the nation. Tack on an income tax range that tops out at nearly 9 percent and retirees on the hunt for a new home state might decide to vacation in Vermont instead.