Forty-one of the 50 states have some form of broad-based income tax, but how retirement income is taxed varies widely. Thirty-five states base their taxes on federal income taxes, so retirement income that's taxed at the federal level, such as tax-deferred individual retirement account contributions, may be taxed at least in part by states. Even Social Security benefits may be taxed, at least partly, by some states.
No Tax States
Nine states have no general income tax in 2012 and, therefore, no tax on retirement funds. Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming don't tax income from any source. New Hampshire and Tennessee tax only income from interest and dividends. State income tax rules, however, are subject to change.
What Is Taxed
California, Connecticut, Nebraska, Rhode Island and Vermont permit no exemptions or credits for pension or retirement income if it is included in your federal adjusted gross income, so basically Internal Revenue Service rules will determine the taxable portion. Roth individual retirement income, for instance, is not taxed at retirement because taxes are paid when contributions are made. Traditional IRA benefits are taxable. Fourteen states tax at least part of Social Security benefits, but 36 don't tax any Social Security benefits.
Military and State Retirements
Sixteen states have special provisions for military retirements, although some, like Missouri, lump military pay in with other public pensions. Ten exclude all federal, state and local pension income. These are Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania.
Other practices vary widely. Virginia, for instance, excludes Social Security benefits and income over $12,000 from any source for those over 65. Colorado offers a $24,000 exclusion but includes Social Security benefits. Similar exclusions vary from $2,000 in West Virginia to $41,110 in Kentucky. Pennsylvania and Mississippi exclude all pension income. Michigan exempts federal and public pensions, from specific states, and private pensions up to $45,120 for individuals. Alabama excludes income from defined benefit pension plans while Hawaii exempts income from contributory retirement plans.
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