If you plan to pack up and move after retirement, you'll probably weigh various factors when eyeing a landing spot, including climate, crime rate and recreational opportunities.
But here's another to put on the list: the state's tax structure.
Reason: After you hit age 70 1/2, you must start taking minimum distributions from your IRA. And those distributions are taxable. So by moving to a low-tax (or no-tax) state, you'll keep more after-tax money from your IRA withdrawals.
State tax bite can add up
IRA withdrawals are subject to both federal and state income taxes. The state tax bite may not seem big, but it adds up quickly.
For example, in a state with a 5 percent income tax rate, you'll owe $25,000 to the state for each $500,000 you withdraw from your IRA.
State taxes are deductible on your federal tax return, which lowers your effective state/local income tax rate. But that's true only if you continue to itemize deductions while taking IRA withdrawals. And even if you itemize, your federal income tax rate might drop in retirement, thus increasing your effective state/local tax rate on IRA withdrawals.
Also, paying large amounts of state/ local income tax can subject you to the alternative minimum tax (AMT).
States can't hunt down retirees
If you plan to move to a low- or no-tax state, don't worry about your former home state slapping you with a tax bill. A 1996 federal law prevents states from taxing IRA distributions that are paid to former residents who now live in another state.
For example, suppose you spent your entire career living and working in New York City. You contributed hundreds of thousands of dollars to a Keogh, a SEP or a profit-sharing plan, taking state and federal tax deductions over the years.
Now you've retired and rolled your plan balance into an IRA. As you turn 70, you can look for a new home in Florida, which has no personal income tax. After relocating, you can withdraw all the money from your IRA and pay no tax to New York—a huge tax savings.
The same rules will apply after your death. Assuming your widow continues to live in Florida, her IRA distributions also will avoid state income taxes. After she dies and the IRA passes to your children, each child may enjoy tax savings, too, if they live in low-tax jurisdictions.
Move to no-tax state before Roth switch
For the same reason, you want to move to a low-tax state before converting your regular IRA to a Roth IRA. Such conversions trigger all the deferred taxes, including state income taxes, so you're better off converting as a Floridian or a Texan, than as a Californian.
Make sure you 'officially' move
As you might suspect, high-tax states aren't crazy about people who flee to no-tax states to cash out their IRAs. In some cases, those high-tax states may go after taxes on IRA withdrawals. How? Those states assert that you haven't really moved. If you are still a New Yorker, you'll owe taxes to New York.
How can you truly be sure you've left your old state behind? Change your driver's license, vehicle registration, voter's registration, bank accounts, etc. to your new state. Make sure you spend more than half the year in your new state if you still maintain a residence in the old one.
State tax summary
For a state-by-state view of individual and corporate , plus a ranking of how "business friendly" each state is, visit www.taxfoundation.org/statefinance.html.
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