Which states tax your 401(k) and IRA withdrawals

Quick answer: States fall into three groups. Some have no broad income tax. Some have one but exempt most retirement income. The rest tax your withdrawals like any other income, often with a partial break for retirees. Rules, rates and age cutoffs change, so check your state's revenue department website and IRS.gov before you act.

The three groups

No broad income tax on wages or retirement withdrawals. Alaska, Florida, Nevada, South Dakota, Texas and Wyoming are the clean examples. Tennessee and New Hampshire used to tax interest and dividends, and both have phased those taxes out. Washington taxes certain large capital gains but has no tax on ordinary income. Confirm the current status of each, because legislatures revisit this.

An income tax, but a generous carve-out for retirees. Pennsylvania generally doesn't tax distributions from a 401(k) or IRA once you've reached retirement age. Illinois and Mississippi exempt most qualified retirement income too. Other states give you a flat exclusion per person, often starting at a certain age. Those exclusions come with income limits and fine print.

Taxes it like any other income. Your traditional IRA withdrawal shows up on the state return next to everything else you earned.

One more wrinkle. A small handful of states tax part of your Social Security benefits, usually with exemptions based on income or age. The list has been shrinking. Most states don't touch Social Security at all, but verify yours.

It depends on which kind of money it is

"Retirement income" isn't one thing, and states treat each piece differently.

• Traditional 401(k) and IRA withdrawals: Taxable federally. States vary widely, as above.
• Roth withdrawals: Qualified withdrawals are generally tax-free federally, and most states follow. This is the reason a Roth is worth having. Money you've already paid tax on stays out of the rearview mirror.
• Pensions: Private pensions are often treated like IRA withdrawals. Some states exempt public-sector pensions or military retirement pay entirely. A few exempt in-state government pensions only.
• Social Security: Federal rules and state rules are separate. Up to 85 percent can be federally taxable depending on your total income. Many states exempt it altogether.
• Brokerage account gains and dividends: Usually taxed as ordinary income or capital gains by states that have an income tax.

So the headline question, "Does this state tax retirees?", is the wrong one. Ask what your income is made of.

A worked example

This is a hypothetical illustration, not a real state or a prediction.

Say you withdraw $50,000 a year from a traditional IRA. You move to a state with a flat 5 percent income tax and no retirement exclusion. That's $2,500 a year in state income tax. Over twenty years, ignoring growth and rate changes, it comes to $50,000.

Now suppose the same state gave you a $20,000 exclusion for retirees. The taxable amount falls to $30,000 and the tax to $1,500. Ask whether you meet the age and income conditions, though, because those cutoffs are where retirees get caught.

And in a state with no tax on this income, it's zero. Real money, but it's not the whole bill.

The cheap-state trap

States that skip income tax still need revenue. They collect it somewhere else.

Compare these across the places you're considering:

• Property tax on a house like the one you'd buy, not the one you own now
• Sales tax, and whether groceries and medicine are exempt
• Homeowners and auto insurance, which in some states have jumped sharply
• Estate or inheritance tax, which some states levy at much lower thresholds than the federal one
• Distance from family and your doctors, which has a dollar cost you'll pay in gas, flights and time

Here's an example, again hypothetical. Saving $2,500 a year in income tax is erased if the house costs $3,000 more a year in property tax and insurance. Run the whole picture. A shorter version of this thinking is in What to Check Before You Retire to a Small Town.

Commentary: We think it's reasonable for a retiree to want the money he's already paid tax on over forty years left alone. Lower-tax states are a legitimate draw. Just count every tax and every cost, not one of them.

Making the move count

Moving doesn't automatically end your old state's claim on you. Some points to get right.

Federal law protects most retirement income from nonresident tax. Generally, a state can't tax qualified retirement distributions paid to someone who's no longer a resident. Once you've truly left, your old state usually can't tax your 401(k) or IRA withdrawals. Certain deferred compensation plans have exceptions, so ask a CPA.

Domicile is about facts, not a mailing address. If you keep your old house, your doctors, your driver's license, your voter registration and your church or club there, your old state may argue you never left. When you move, change the license, register to vote, file a declaration of domicile where available, move the doctors and spend most of the year in the new place. Keep records.

Plan the year you move. In the move year you may file part-year returns in two states. If you're considering a Roth conversion, the state where you do it matters, because the conversion is taxable income in the state you're a resident of that year. A CPA can tell you whether doing it before or after the move makes sense. Our piece on which retirement account to spend from first covers how the order of withdrawals shapes your tax bill.

Before you sign anything

1. List your expected income by type: traditional withdrawals, Roth, pension, Social Security, brokerage.
2. Pull up each candidate state's tax rules on its revenue department site. Look for the retirement income exclusion and the age cutoff.
3. Price the total cost of living there: property tax, sales tax, insurance.
4. Look at the federal side on IRS.gov and SSA.gov so you understand how Social Security is taxed no matter where you live.
5. Rent for a season before you buy, if you can. The first January will tell you what the brochure didn't.
6. Sit down with a CPA who knows both states, and a fee-only fiduciary adviser, before you list the house.

This is general education, not individual tax, legal or financial advice. Limits, ages and thresholds change, so verify against the official source, and check your own situation with a fee-only fiduciary adviser, CPA or estate attorney before you act. If a settlement or beneficiary question comes up while you're sorting this out, your will doesn't control most of your money, and it's worth a look at the same time.

Pick the place you want to live first. Then make sure the tax bill doesn't talk you out of it.