Why Your Retirement Income May Depend on Where You Live

There are lots of different taxes in this country: federal income, state income, capital gains, sales and property, to name a few. When it comes to planning for retirement, it’s important not to forget about taxes.

In previous columns on taxes, I’ve focused mostly on federal income tax, but today, I want to discuss state tax planning.

When it comes to taxes, I always consult my favorite CPA, Bob Leins of Turner, Leins, and Gold, for advice. Here’s what he has to say about state income tax planning for retirement:

The first step is to find out if you will have to pay state income taxes on your Civil Service Retirement System or Federal Employees Retirement System benefit, Social Security income, and Thrift Savings Plan distributions. The following states don’t have a state income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming, New Hampshire and Tennessee. But the latter two states tax dividends and income from investments. Some other states exempt some retirement income from taxation.

The TSP and Social Security Administration will not withhold any state income tax. As a result, generally your source for state income tax withholding will be the Office of Personnel Management, but not until OPM has finalized your retirement claim. You can choose to have more state income tax withheld from your CSRS or FERS benefit if you need to compensate for no state tax withholding from TSP distributions or Social Security (if you need to pay state tax on these benefit payments).

If you choose not to have state tax withheld from your retirement benefit, you can make estimated tax payments directly to your state tax office.

There are two good sources for information about state income taxes and retirement: The National Active and Retired Federal Employee Association’s annual state tax roundup, published in the April edition of NARFE magazine, and Kiplinger’s state tax map, which is updated every year. The Wall Street Journal published a summary of state taxation of retirement income--but that was in 2013, so be sure to check that the rules haven’t changed in your state.

One state that changed its rules several years ago is North Carolina. The state now exempts CSRS retirement benefits from state income tax, but requires most FERS retirees to pay a tax. This is because of a 1991 North Carolina Supreme Court ruling known as the Bailey Decision. Under the ruling, in order to be exempt from state income tax, a retiree has to have had five years of creditable government service prior to Aug. 12, 1989.

During your transition to retirement, you may be placed in interim retired status while OPM is processing your retirement claim. OPM only allows federal tax withholding from interim payments, not state tax withholding. You might receive only one or two interim payments if your claim is processed quickly, but if OPM has a backlog of applications, or if there are problems with your paperwork, you can expect to receive multiple interim payments. It is important to decide how to pay your state taxes during this time.

Once you’re retired, you can use OPM Services Online to make changes to the withholding from your CSRS or FERS retirement benefit. OPM is required by law to update your federal income tax withholding based on formulas set by the IRS each year. You can change your tax withholding amount at any time. It’s a good idea to check the amount of your federal and state withholding every year.

Photo: Flickr user Murduck Rubbaduckie