Southern California is a fantastic place to live in many ways, but there are a handful of negatives. Obviously, the traffic is one of them, and we have the highest state income tax rate in the country.
Even if you have no problem with any of the above, you may consider spending your retirement years in another state for other reasons. If you are in this position, you should definitely take taxation into consideration.
There is a federal estate tax that will follow you wherever you go, but there is a high credit or exclusion that you can use to transfer a certain amount tax-free. In 2021, the exclusion is $11.7 million.
It will remain at this level indexed for inflation through 2025, but it is going to be reduced to $5.49 million in 2026 when a provision in the Tax Cuts and Jobs Act expires. The maximum rate of the federal estate tax is 40 percent.
In addition to the federal tax, there are a total of 12 states that have state-level estate taxes, and there is an estate tax in the District of Columbia. California is not in this group, so you do not have to leave the state to avoid a state-level estate tax.
These are the 12 states with estate taxes:
- New York
- Rhode Island
Your estate could be subject to one of these state-level income taxes if you own valuable property in one of the states. The state-level exclusions are considerably lower than the federal exclusion, so this is something to look into if you own out-of-state property.
In Oregon, the exclusion is just $1 million, and the Hawaii estate tax exclusion is $5.49 million at the present time.
We should point out the fact that there is no gift tax in any of the states except Connecticut. As a result, people in these states can give lifetime gifts to mitigate their estate tax exposure.
On the federal level, there is a gift tax that is unified with the estate tax, so you cannot simply give large gifts while you are living to avoid the estate tax.
You may assume that the term “inheritance tax” is another way of referring to an estate tax, but this is really not the case. An estate tax is levied on the entire taxable portion of an estate before it is distributed to the heirs, so there is one instance of taxation.
On the other hand, an inheritance tax can be levied on distributions to each individual inheritor that is not exempt. As a result, inheritors could be forced to pay an estate tax and an inheritance tax.
There is no federal inheritance tax, and there are just six states that have inheritance taxes. Iowa is among them right now, but their inheritance tax is being phased out. The other five states are New Jersey, Pennsylvania, Kentucky, Maryland, and Nebraska.
People that are residents of Maryland are faced with the prospect of paying an estate tax and an inheritance tax. The good news is that close relatives are typically exempt from inheritance taxes.
If you inherit property that is located in a state that has an inheritance tax, it would be a factor for you if you are not exempt.
There are nine states that do not have state-level income taxes, so there are no state taxes on retirement income. These states are Nevada, Alaska, Florida, Texas, South Dakota, New Hampshire, Tennessee, Washington, and Wyoming.
Illinois, Mississippi, and Pennsylvania are states with state-level income taxes, but they do not tax IRA, pension, or 401(k) distributions. People in Hawaii and Alaska do not have to pay taxes on pensions, but they do pay taxes on retirement account distributions.
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