I’m sitting on the sofa in my office, which is in Virginia. Looking out the window, I can see both Virginia and Maryland. There’s an often-incorrect assumption that when you cross the bridge from Virginia into Washington, D.C., your taxes jump. The reality is much more complicated.
Income taxes, which is how we often gauge whether taxes are “high” or “low,” do go up if you move into D.C. But property taxes come down. So, if you’re retired, you may actually be better off in D.C.
However, D.C. has an estate tax, and Maryland has an estate and an inheritance tax, so depending on your balance sheet, you may be better off staying in Virginia. You can see how things can get complicated quickly.
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My goal in this article, as a CFP® and president of Exit 59 Advisory, is to help you avoid making a big decision on where you move in retirement for tax purposes — which I think is often a mistake in and of itself — without understanding the full tax picture.
Five taxes to consider
1. Income tax
You’ve heard of people moving from California to Texas. We have several clients in the process of changing residency from New York to Florida. This isn’t because Texas has delicious BBQ or because Florida has Publix. It’s typically because folks want to ditch the income tax. While this is almost always the most consequential tax when you’re working, that isn’t always the case for retirees.
Nine states don’t tax earned income. However, like the federal government, most states do have a progressive income tax, where the rate rises with your income. Be sure you understand that progression and what effective or average rate you’re likely to pay.
When we have a relocation in retirement in a client’s financial plan, it becomes pretty clear what will happen to their income, capital gains and estate taxes, all else being equal. We recently had a client moving from California to Texas and were able to tell them how much money they would save, and therefore, could spend elsewhere. We used specialist software to do that, and you can use our subscription to access it for free.
2. Capital gains tax
Capital gains rates are more favorable than income tax rates at the federal level as a way to incentivize investment. The same cannot be said about state treatment of capital gains.
In most states that levy an income tax rate, the same rate is applied to capital gains. When my parents sold their (not so) forever home in Maryland, it basically looked as though the capital gain was income. It was taxed at the same rate.
There are some notable exceptions. Washington state, for example, doesn’t have an income tax but does have a capital gains tax. If your savings are all in retirement accounts, you don’t have too much to worry about. But let’s say you sold a business and almost all your assets are in non-retirement accounts. For you, Washington state may not be a good tax destination.
3. Sales tax
I’m a (perhaps too) proud graduate of the University of Delaware. Delaware is often referred to as the “tax-free state.” Incorrect. Delaware doesn’t have a sales tax. It does have income and property taxes, though those property taxes are extremely low by the beaches. Take notes, Florida.
Sales taxes are more straightforward, except that there are adjustments on certain types of purchases. Like to eat out? Then Washington, D.C., is no good. To be clear, the food is good. Like to drink? Avoid Washington state.
4. Property taxes
You might be unpleasantly surprised when you arrive in Texas for the BBQ or Florida for the Publix, and you’re presented with a massive property tax bill. As the saying goes, “There’s no such thing as a free lunch.”
States need income, and that income gets raised somewhere. The key is landing in a state where that somewhere or someone is not you. If you’re looking at a second home, you could consider renting instead of buying, so long as you can still satisfy the residency requirements.
Another thing to evaluate when it comes to property taxes is the property’s assessed value, which can sit close to the market value or far below. A high tax rate on an assessed value much below market value may not sting as much as you think.
5. Estate and inheritance taxes
While estate and inheritance taxes are often used interchangeably in the context of death taxes, they are not the same. Estate taxes are levied on the decedent’s estate. Inheritance taxes are paid by the beneficiary.
Fewer and fewer states have either of these taxes. As of this writing, 17 jurisdictions. However, if you have enough money and haven’t done enough planning, estate taxes can be punitive. Before you move because of it, see if you can plan around it.
Why the full picture is even more nuanced
There’s an exception to every rule in our tax code, and nothing is black and white. While an income tax rate may be high on the surface, many states exempt retirement income sources such as Social Security, pensions and retirement account distributions. Many have income phaseouts or caps on those exemptions.
Property taxes can be discounted in multiple jurisdictions if you meet certain requirements.
And let’s not forget the cost of living. You may be someone who had spreadsheets for all of the above but still wound up with astronomical grocery bills, mortgage payments and restaurant bills because you weren’t the only one who moved to Florida during Covid.
If you do want to move for tax purposes retirement, my hope is that you go in with your eyes wide open.