Selecting a retirement locale requires careful planning - Personal Finance

Healthcare Financial Management, Dec, 2001 by William G. Kistner

Where to live during one's retirement is a decision that should not be made lightly. Although many retirees want to stay in their current homes, many others envision a very different lifestyle in retirement, which could include living in another city, state, or even a different country. Regardless of whether a person plans to move or stay put, a retiree's financial situation plays an important role in the final decision.

Careful attention should be given to the financial implications of relocating. Future retirees should consider how real-estate transactions and state taxes will affect their financial position in retirement.

The impact of state taxes on income, real estate, purchases, personal property and inheritances should be projected. Each state has its own tax site on the Web (see www.taxsites.com/state.html). These sites provide access to a wealth of useful information.

Establishing a new home state. Establishing a primary residency is important because it determines where one must pay income tax and certain other taxes. Unfortunately, establishing residency involves more than simply completing a form and declaring which state one is residing in. A person's residency status can be challenged by a state that believes that person's primary residence is located in another state.

The basic rule is that people are subject to the tax system of the state in which they reside at the time the income is received. When determining whether an individual is a resident, states look at evidence such as:

* The amount of time the person physically spends in the state during the tax year;

* Whether the person owns residential property in that state;

* Whether the person is registered to vote in the state;

* Whether the person has automobiles registered in the state; and

* Whether the person uses that state as his or her address on Federal income-tax returns.

If a person does not clearly establish residence in a state, it is possible that two states can claim that person as a resident and subject all of his or her retirement income to their tax systems. In that case, the individual may be able to obtain some tax credits from one state to offset part of the tax paid to another state on the same retirement income.

Before 1996, some states taxed nonresidents on the amounts of retirement income that they earned while employed in those states. Some states with such "source taxes" were aggressively pursuing nonresidents and subjecting them to retroactive tax bills and penalties. A Federal law now generally prevents states from taxing the retirement income of nonresidents.

Income taxes. States take one of four approaches to taxing retirement income from qualified pensions, individual retirement accounts (IRAs), and savings plans. It is important to note that income from interest and dividends, full- and part-time employment, self-employment, and rental real estate are not considered retirement income and typically are subject to state income tax.

Some states have no income tax at all. Retirement income, whether received as a monthly check or a lump sum, will not be subject to income taxes in states that take this approach. States with no income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. (Note that Florida does have an intangibles tax, a tax assessed on the fair-market value of securities.)

Other states have an income tax, but do not tax retirement income. It is important to check the state's definition of retirement income. Some states define it broadly as any income received from any type of retirement plan, such as a company plan, government plan, or IRA. Other states even define retirement income as any income received from any source provided the recipient is over a certain age. Other states define it more narrowly as only income received from qualified pension and profit-sharing plans. States that do not tax retirement income are Hawaii, Illinois, Mississippi, New Hampshire, Pennsylvania, and Tennessee.

In a third approach to retirement-income taxation, states tax retirement income but give a partial tax break to taxpayers over a certain age. Eligibility ages range from 55 to 65. For example, New York exempts from taxation up to $20,000 of annual pension and annuity income per individual over age 59[1/2]. It is important to check the eligibility age for such partial tax breaks and the definition of eligible retirement income. States that take this approach are Arkansas, Colorado, Delaware, Louisiana, Maryland, Michigan, Montana, New Jersey, New York, North Carolina, Ohio, Oregon, South Carolina, Utah, Virginia, and West Virginia.

Finally, some states give no special income-tax treatment to any type of retirement income. Such income simply is added to one's other taxable income and taxed at the state's ordinary income-tax rate. States that take this approach are Alabama, Arizona, California, Connecticut, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Maine, Massachusetts, Minnesota, Missouri, Nebraska, New Mexico, North Dakota, Oklahoma, Rhode Island, Vermont, and Wisconsin, as well as the District of Columbia.