There are seven states with no income tax, meaning these seven states don’t tax retirement income
- South Dakota
Why is this important? Because, depending on the type of account(s) you’re using to accumulate money for your retirement, taxes could take a meaningful bite.
Here’s what I’m going to help you figure out
- What your tax liability could be in retirement
- Whether or not your money is at risk from taxes
- What you can proactively do to lessen that risk
In case you’re curious, here are the seven states with the highest state income tax.
- California 13.3%
- Hawaii 11%
- New Jersey 10.75%
- Oregon 9.9%
- Minnesota 9.85%
- District of Columbia 8.95%
- New York 8.82%
Now, before you up and move from California to Texas, I want you to know the whole story.
Let’s get started.
What your tax liability could be in retirement
Our tax system is enormous and confusing. That being said, I’m going to help you make heads and tales of it.
I’ll cover several types of taxes we pay, and at the end, give an example to bring everything together.
Our progressive system. We have a progressive system for income tax, meaning you pay more tax the more income you earn. So, just because you see California’s tax rate of 13.3%, doesn’t mean you’re going to owe 13.3% of all of your income in taxes. This chart can help clarify this concept
|rate||Taxable income bracket||Tax owed|
|1%||$0 to $8,932||1% of taxable income|
|2%||$8,933 to $21,175||$89.32 plus 2% of the amount over $8,932|
|4%||$21,176 to $33,421||$334.18 plus 4% of the amount over $21,175|
|6%||$33,422 to $46,394||$824.02 plus 6% of the amount over $33,421|
|8%||$46,395 to $58,634||$1,602.40 plus 8% of the amount over $46,394|
|9.3%||$58,635 to $299,508||$2,581.60 plus 9.3% of the amount over $58,634|
|10.3%||$299,509 to $359,407||$24,982.88 plus 10.3% of the amount over $299,508|
|11.3%||$359,408 to $599,012||$31,152.48 plus 11.3% of the amount over $359,407|
|12.3%||$599,013 or more||$58,227.85 plus 12.3% of the amount over $599,012|
State AND Federal income tax. While this post is focused on state taxes, please keep in mind you may be liable for both state and federal income taxes. You can find more information here.
Property tax. Every state levies a property tax on it’s residences which is tied directly to the prosperity’s value. You can find more information here.
State and local sales tax. While there are five states that don’t levy sales tax, all others do. You can find more information here.
A real world example
Let’s use a married couple with household income of $100,000, spending $50,000 a year, and living in a $500,000 home. We’ll look at what their tax liability would be like in California and Texas.
In California, they’d pay
- $5,890 in state income tax
- $3,650 in property tax and
- $3,625 in sales tax
- $13,165 total
In Texas, they’d pay
- $0 in state income tax (Texas doesn’t have state income tax)
- $9,000 in property tax and
- $3,125 in sales tax
- $12,437 total
Is your money at risk from taxes?
If you’re saving in these places, you’ll may be liable for taxes when you withdraw money
- Pre-tax 401(k). Every year you contribute to your 401(k) in this way, you receive a tax benefit. Therefore, all the money you withdraw (principal and growth) will be taxable.
- Traditional IRA. Every year you contribute to a traditional IRA, you receive a tax benefit. Therefore, all the money you withdraw (principal and growth) will be taxable.
- Pension income. All the money you receive from a pension will be taxable.
- SIMPLE IRA. Every year you contribute to your SIMPLE IRA, you receive a tax benefit. Therefore, all the money you withdraw (principal and growth) will be taxable.
- SEP IRA. Every year you contribute to your SEP IRA you receive a tax benefit. Therefore, all the money you withdraw (principal and growth) will be taxable.
- Social Security. Depending on your financial situation, a portion of your Social Security income could be taxed. You can learn more here.
Which accounts won’t be taxed?
- Roth 401(k). The income you withdraw from a Roth 401(k), principal and interest, will be income tax-free.
- Roth IRA. The income you withdraw from a Roth IRA, principal and interest, will be income tax-free.
- There are other tax-preferred accounts such as cash value life insurance and tax-free municipal bonds which you could consider.
What you can proactively do to lessen that risk
If you’d like to create more non-taxable retirement income, here are three ways to do it.
- Shift your current strategy. Begin making contributions to a Roth 401(k) or Roth IRA. Consider cash value life insurance and or tax-free municipal bonds. If you’d like to talk with someone, you can connect with one of our partners here.
- Consider a Roth conversion. This is when you transfer funds from a traditional IRA into a Roth IRA. You’ll owe income taxes on the amount you transfer in the year you complete the transfer, and the taxes cannot be paid by the IRA. If you choose to pursue this, I highly recommend speaking with a professional.
- Consider a “back door Roth IRA.” Because there are rules around who can contribute to a Roth IRA, this is a way for high income earners to do so. Simply put, you make a traditional IRA contribution and then execute a Roth conversion. You’ll owe income tax on the amount you convert. Again, I highly recommend speaking with a professional.
Now you can call your Realtor.
As with many things financial and tax related, this can be confusing. We’ve got great Partners to help guide you on your path to financial and retirement success.
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Good luck on your journey!
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