Having to deal with paying both federal and state income taxes is bad enough. But when you're retired and living on a fixed income, having to pay taxes on your Social Security and pension benefits is almost an insult.
The vast majority of states give retirees a break when it comes to their taxes, exempting much or all of their Social Security and pension income. But according to figures from Wolters Kluwer and CCH as well as the Retirement Living Information Center, a small number of states give retirees much more limited tax breaks on their retirement income, generally taxing both Social Security and pension income. Let's look at six states that hit retirees hard at tax time.
6. North Dakota
North Dakota has generally low tax rates, ranging from 1.51% at the lowest bracket to a maximum of 3.99%. With relatively low sales tax rates of 5% and an average property tax liability of about $1,025 per person, North Dakota's taxation of retirement income adds only marginally to a reasonable tax burden for retirees. Retirees may also be eligible for a homestead credit against property taxes. Moreover, with energy companies Continental Resources (NYSE:CLR), Kodiak Oil & Gas (NYSE: KOG), and Whiting Petroleum (NYSE:WLL) cashing in on Bakken riches, they'll be sending more tax revenue into state coffers, potentially allowing the government to give retirees further breaks in the future.
5. West Virginia
West Virginia generally taxes Social Security to the same extent that it's includable in federal taxable income, and certain amounts of retirement income are eligible for exclusion depending on filing status. West Virginia has five tax brackets that go from 3% to 6.5%. But with rock-bottom per-capita property taxes of less than $750, the overall tax burden for residents is less than in many other states that tax Social Security and pension income.
Like West Virginia, Nebraska treats Social Security as taxable in the same way that federal tax law calculates taxable Social Security income. Nebraska's four tax brackets range from 2.56% to 6.84%. Property taxes of nearly $1,500 per person put the state in the top third in the country, and a 5.5% sales tax also puts a burden on retirees.
3. Rhode Island
Rhode Island taxes Social Security in the same way that federal law does and includes pension income fully. Rhode Island's tax rates come in three different brackets of 3.75%, 4.75%, and 5.99%. Yet even though those rates are lower than Nebraska's, a 7% sales tax and an average property-tax burden of nearly $2,100 are enough to make the overall impact on typical retirees somewhat harsher.
Minnesota has three tax brackets ranging from 5.35% to 7.85% and taxes Social Security to the same extent the federal government does. The state taxes pension income even if the pension was earned outside the state. Property taxes averaging more than $1,400 per person and sales taxes of 6.875% also rank in the top half of the nation, making the potential hit on retirees even larger.
Unlike most other states, Vermont taxes Social Security fully and has no exemptions for retirement income except for Railroad Retirement benefits. Vermont's tax rates are the highest among these six states, with a low bracket of 3.55% giving way to four higher brackets from 6.8% to 8.95%. Moreover, with property taxes of nearly $2,200 per person and a 6% sales tax, Vermont doesn't give retirees much of a break in other areas of taxation, either.
A taxing proposition
Of course, state income taxes are only one small part of the living expenses that retirees have to pay, and for many of these states, overall costs of living are well below the national average. Nevertheless, forcing retirees to bear the same or nearly the same tax burden on their retirement income as workers pay on their wages and salaries is a practice that most states have given up on, and retirees in these few holdout states need to be aware of the tax consequences that their choice of residence will have on their finances.