State-Specific Retirement Savings: 41 States with Tax-Friendly Policies

Key Points

• The good news is that most states don’t tax any Social Security income.

• But larger pensions and retirement accounts are subject to at least some taxation.

• Everyone remains subject to the same federal income tax rules no matter where they live.

• The $23,760 Social Security bonus most retirees completely overlook ›

Can where you live affect how much of your retirement income you keep? As a matter of fact, it can. A small number of U.S. states are very tax-friendly to begin with, while the majority of states are quite accommodative to most retired people.

Here's what you need to know about each state's current treatment of retirees' income. Just be warned: once you're done reading, you just might be motivated to make a major move.

Social Security benefits are (almost) always untaxed

It was never intended to be anyone's sole source of retirement income, but Social Security is certainly an important one for plenty of people. The Center on Budget and Policy Priorities reports that the federal entitlement program is the single-biggest source of cash flow for the bulk of its retired beneficiaries, accounting for at least half of the income for 4 out of every 10 recipients.

Given that the program's average monthly benefit is now only $2,002 and caps out at a maximum of $5,108 per month, anyone who's highly dependent on Social Security income isn't exactly living lavishly. Fortunately, most states don't impose any income tax on these benefits. A total of 41 states don't tax Social Security income, in fact, in addition to Washington D.C.:

1. Alabama

2. Alaska

3. Arizona

4. Arkansas

5. California

6. Delaware

7. Florida

8. Georgia

9. Hawaii

10. Idaho

11. Illinois

12. Indiana

13. Iowa

14. Kansas

15. Kentucky

16. Louisiana

17. Maine

18. Maryland

19. Massachusetts

20. Michigan

21. Mississippi

22. Missouri

23. Nebraska

24. Nevada

25. New Hampshire

26. New Jersey

27. New York

28. North Carolina

29. North Dakota

30. Ohio

31. Oklahoma

32. Oregon

33. Pennsylvania

34. South Carolina

35. South Dakota

36. Tennessee

37. Texas

38. Virginia

39. Washington

40. Wisconsin

41. Washington, D.C.

42. Wyoming

It's worth mentioning that just because a state doesn't appear on the list above doesn't necessarily mean you'd owe state income taxes on any Social Security benefits you collect while living there. In several cases -- as is the case with federal taxation of your Social Security income -- some or even all of it can qualify as exempt.

You'll want to compare your retirement income to a particular state's tax thresholds to see how much (if any) income taxes you would actually owe there.

Taxation of other retirement income

Tax-free Social Security benefits are obviously a win for retirees. But they're not the only source of income for most seniors even if they're the most important one for many of them. Plenty of retirees also have 401(k) accounts and traditional IRAs, and withdrawals from those accounts are counted as taxable income. Some are also still drawing from pensions, or will eventually do so. What about these sources of retirement income?

Nine states don't tax any retirement income, but not because they're specifically looking to give their senior residents a break. They simply don't impose any state-based income taxes at all. They rely instead on corporate taxes and sales taxes to fund their state government programs. Those nine are:

1. Alaska

2. Florida

3. Nevada

4. New Hampshire

5. South Dakota

6. Tennessee

7. Texas

8. Washington

9. Wyoming

Note that while New Hampshire previously imposed income taxes on its residents' dividends and interest income, as of the beginning of this year, those taxes are no longer in effect.

Then there are four states that do tax the incomes of retired residents, but only ordinary work-based wages. Qualified retirement income coming from pensions, individual retirement accounts, and the like aren't subject to taxation in:

1. Illinois

2. Iowa

3. Mississippi

4. Pennsylvania

Each of these four states still has reasonable rules about who can actually claim eligibility for tax-free retirement income. In Iowa, for instance, you'll still need to be at least 55 years old to qualify. In Mississippi and Pennsylvania, retirees and their plans must also meet certain requirements. Check out each state's tax/revenue website for details if these are states you live in or might retire in.

As for military retirement benefits or pensions offered to state employees (and other comparable pension programs), most states offer some tax breaks for these plans, while several don't tax this income at all. The rules can be a bit inconsistent from one state to another, though, and are regularly changing anyway. So, if this applies to you and there's a certain state you have on your retirement radar, you'll want to check for its specific rules.

Just keep the bigger picture in mind

There's more to the matter than simply minimizing your yearly tax bills, to be clear. For instance, there's also the cost of living -- many of the states that don't have income taxes can also be relatively expensive to live in. There's also quality of life to consider, and the possibility that a move to a tax-free state would take you away from friends and family.

Also bear in mind that while some states may be tax-friendly to retirees, again, you'll still be subject to the same federal taxes no matter which state you live in. This can include a portion of your Social Security income. Federal taxes, of course, account for the bulk of everyone's yearly taxes. So, if you're looking for a huge tax break, moving to a different state probably isn't going to make a life-changing difference on that score.

Still, if you were considering a geography-based lifestyle change anyway, and as much as a few thousand bucks extra a year would make a difference for you, picking a destination that could cut your tax bill certainly isn't the craziest of ideas.

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State-Specific Retirement Savings: 41 States with Tax-Friendly Policies was originally published by The Motley Fool