Now that the Trump administration's highly anticipated new tax legislation is airing out, some living in high-tax states such as California, New Jersey or New York are probably weighing the pros and cons of staying put or pulling up stakes and retiring to lower-tax states, like Florida or Texas.
I am actually seeing plenty of examples coming out of California, where I have a financial advisory practice. The Golden State serves as the perfect backdrop for this issue since it's also the highest-taxed state in the country.
We've been at this for a while. For 25 years I have seen clients leave the state for tax-related reasons. Once you've counted the beans and weighed the cost-to-benefit, it's important to note that leaving comes with unforeseen kickbacks, both negative and positive.
First off, I get it: Anyone dealing with sticker shock in light of the potential local, state and property taxes they face under the new laws could be tempted to jump ship and make tracks for so-called "tax-free" states. But there is still a price to pay. To that point, there are a few things I'd tell my clients to consider when we are discussing the option to leave the state.
The new tax law affects people because of the limitations it places on deductions they can make on their state and local income and property taxes. If your finances aren't greatly impacted by the changes, they might serve as a mere annoyance, but that is only one potential scenario out of many. If a look at the numbers has you flinching and ready to call the movers, it's time to settle down and weigh the pros and cons.
The first thing I suggest is a calculation of what it actually costs to live in the current state, with an emphasis on the taxes being paid out.
For example, imagine that you live in California and make $100,000 in income, but you are paying $7,000 of that in taxes to live in the state. Meanwhile, in Nevada, it's costing nothing for people making the same amount of money to live the next state over. Infuriating? Possibly. But here's the thing: For a retired investor, or someone staring down retirement any minute, the stakes are even higher because the reliable income stream is limited. And no one wants to watch their money dwindle due to avoidable expenses.
For most, the ultimate objective is not to merely accumulate as much money and as many assets as they can. Rather, their ideal financial picture includes having enough to be able to spend their time and money as they so choose.
This is different for everyone, but if you are grandparents living in the same state as your family, the decision to move across the country for a tax break could shake out to mean a loss of being more available for quality time. The same goes for friendships and community involvement. Jetting from the place where you have put down roots and are established might be a great adventure ... or, it might make you woebegone and wistful for what is, well, gone.
If you're feeling ready to hit the road, one option I suggest is that, instead of packing up and heading out for good, you put the relocation place "on trial." This could manifest itself in several different ways, but a key point is to rent out rather than sell the high-tax state property and buy a place in a lower-tax place outright, and give it a year first.
Believe it or not, if you're used to the lifestyle being based in California provides, relocating to Texas, even if it's to a golf course community in Texas, will take some adjustment. And, it's entirely possible that you won't like it.
That said, I have two clients who have successfully made this leap by moving to a country club community in Texas that is similar to the one they had in Northern California. The couple has a retirement income of roughly $200,000, made up of Social Security, a small pension, individual retirement account distributions and dividends. In California, this is taxed at about 10 percent. Unlike the federal government, where capital gains and dividends are taxed at more favorable rates, California hits all taxable income with the same high tax rates.
They also pay fairly substantial property taxes on their homes. It's not that property tax rates are all that high in California (they are about 1.25 percent of the value), it's that home prices there are astronomical. One slight relief that many California residents, including them, have had is an ability to deduct state income and property taxes against federal income taxes, reducing their total taxes by 25 percent. Given that their combined income and property taxes is about $35,000 per year, their effective rate was approximately $26,000 per year. But with the new tax bill, their effective California tax bills will increase by $9,000; a 35 percent increase in taxes for the privilege of living in California.
After we evaluated their numbers, they said this was the last push they needed to leave the state. They already had one child living in Austin, Texas, and planned to sell one of their California homes and buy a primary residence in Texas. From our calculations, not only will this save them a ton in income taxes, but their overall cost of living will be much lower.
We can't all be that lucky, so a gut-check about your overall objective will serve you well as you go along. Saving money is great, but it's important to ask if it will make up for the loss of family time or community.
If you aren't able to downsize and buy a second place, cutting the cord can be costly. Let's say you leave, decide the new place isn't all it was cracked up to be, and then find yourself priced out of the community you've left. We've seen clients leave and return more than once because the retirement nirvana they expected never materialized. If you've wisely rented the place out where you once lived and rented in your relocation place, changing your mind will be easier and less of a hassle.
Finally, I think it's important to keep in mind that you're not expected to instantly know what to do in light of the tax changes. Everyone's situation is different, and what serves one client or friend might not serve another. But, the proper conversation with an advisor and tax professional can help to put one's restless mind at ease.
With a better sense of what their actual costs, priorities and overall objectives are, anyone can move forward confidently no matter what tax implications are coming down from Washington.
— By Scott Hanson, co-founder and senior partner at Hanson McClain Advisors