One of the many perks of retirement is the freedom to live wherever you want. No longer tied down to a location by your job, you can move for better weather, to be closer to family, or to reduce your cost of living. But retirees often question: Which state will tax my pension income? If you receive a pension from a state with a high individual income tax rate, such as California, New York, or Maine, and move to a state with low or no individual income taxes, will you have to continue paying taxes to the state in which you earned that pension?
Fortunately, thanks to the Pension Source Act of 1996 (P.L. 104-95), “no state may impose an income tax on any retirement income of an individual who is not a resident or domiciliary of such state.” In other words, the only state that can tax your pension income is your resident state. However, the Pension Source Act still allows states to define residency on their own terms, so retirees who split their time between two states may still have to pay income taxes to both states.
The good news is that the Act gives retirees some pretty valuable tax planning opportunities. Retirees with pension income from a state with a high individual income tax rate can relocate to a state with no individual income tax, such as Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming. Or move to a state that doesn’t tax pension income, such as Alabama, Mississippi or Pennsylvania.
What Does That Mean for Pennsylvania?
Keep in mind that many states, Pennsylvania included, aren’t too pleased about losing tax revenue when retirees leave the state. The Pennsylvania Department of Revenue (DOR) has been known to challenge the nonresidency status of certain retirement payouts. Retirees who relocate to Florida, for example, but keep a home in Pennsylvania should carefully document the number of days spent in Florida versus Pennsylvania. Spend more than 183 days in Pennsylvania, and the state could decide that you’re a resident of both states.
Although Pennsylvania does not tax retirement benefits, they could attempt to reclassify recent retirement payouts as severance. Severance payments are taxable income for Pennsylvania residents, as is interest, dividend, and capital gains income.
Before you put your house on the market, pay attention to the trade-offs. Some states with no income tax impose higher-than-average sales tax or property taxes or tax a broader array of goods and services. Don’t base one of life’s biggest decisions (where you live) solely on tax considerations.
ABOUT THE AUTHOR
Matt is a Senior Manager with Brown Schultz Sheridan & Fritz and a key member of the Firm’s Tax Department. Matt has over ten years of experience servicing closely held and family-owned businesses in numerous industries, including manufacturing, distribution and construction/real estate.