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Mark Miller: Remaking Retirement

How Retirees Are Taxed

Policies on income and property levies can differ starkly from state to state.

The fight leading up to passage of the new tax law featured a controversial battle over deductibility of state and local taxes, with the final version limiting deductibility to $10,000 beginning this year.

The controversy put a focus on differences in tax policy among high- and low-tax states. But the states also differ sharply when it comes to taxing retirees. A few exempt all retirement income from taxes, and many exempt all Social Security income. Many states give seniors a break of some kind on property taxes; policy on taxation of income from pensions, 401(k), and IRA accounts varies widely.

The policy of exempting retirement income dates to a time when elderly poverty rates were much higher than they are today. As recently as 1970, almost 25% of Americans older than 65 lived in poverty, according to the Census Bureau; now it’s around 9%. The federal government didn't tax Social Security until the 1980s.

Today, seniors still receive two important tax breaks at the federal level.

First is the partial exemption of Social Security benefits. No one pays taxes on all of their benefits; taxes are determined using a unique formula that starts by determining what Social Security calls "combined income" (or "provisional income"). This is equal to your adjusted gross income plus nontaxable interest plus 50% of your Social Security.

Seniors with incomes below $25,000 ($32,000 for joint filers) are exempt from any taxation of benefits. For people with incomes between $25,000 and $34,000 ($32,000 and $44,000 for joint filers) up to 50% of benefits are taxable; above those levels, up to 85% is taxed.

The federal tax formula was crafted to initially target higher-income households, but the share of benefits taxed has risen over the years, because the income thresholds for taxation aren't indexed for inflation or real income growth. According to the Social Security Administration, the proportion of beneficiary households whose benefits are taxed has risen since 1984 from less than 1 in 10 to more than half. The SSA reports that about 56% of beneficiary families will owe federal income tax on their benefits from 2015 through 2050.

Seniors also get a larger standard deduction on their federal taxes. Along with the new standard deduction for 2018 ($12,000 for singles and $24,000 for couples), each taxpayer over age 65 can take an extra $1,300 this year. The deduction is indexed annually for inflation--although its growth will be slower under the new tax bill, which adopts the chained CPI as the yardstick for measuring inflation for tax purposes.

State Policies Vary Widely
At the state level, taxation of retiree income is a very mixed bag. How mixed? The Institute on Taxation and Economic Policy tracks how states treat retirement income, and we've prepared a downloadable PDF if you're interested in diving into the details or comparing states.

Seven states have no personal income tax at all: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Among those that do, here's how it breaks out when it comes to retirement income.

Social Security: 31 states exempt all Social Security benefits from tax; six follow the federal formula. The remaining six use unique formulas or tweak the federal formula.

Pensions: Four states exempt all pension income; from there, policies vary widely. Some states tax pensions for all but military personnel, for example.

Property tax: This might be the area of broadest agreement--all but five states (Nebraska, North Carolina, Ohio, Nevada, and Washington) give seniors some kind of relief on property taxes, including property tax circuit breaker credits, homestead exemptions, and income-based property tax credits. The breaks make sense, since most seniors live on fixed incomes and there is no fundamental alignment between income and changes in property assessments and taxes.

Other tax breaks: Many states give retirees an extra personal exemption or standard deduction.

Policy Going Forward
Will the new tax law's state and local tax cap change the way older Americans think about where to live in retirement? Meg Wiehe, ITEP's deputy director, doubts it.

"Most of the research shows that higher taxes on wealth don't result in much out-migration, and retirees consider a much broader range of issues when they think about where to live, or moving somewhere," she says.

Wiehe also thinks the higher standard deduction will render the state and local tax cap moot for a majority of retirees.

"Think of someone in retirement--or close to it--who is getting toward the end of a mortgage," she says. "They may not have that much mortgage interest to deduct. Many people will be better off with the standard deduction, especially with the additional standard deduction for seniors."

Nowadays, it would make sense for more states to take a careful, progressive approach to taxing retirement income. While it makes no sense to burden low-income seniors struggling to scrape by, exempting wealthy seniors from taxes also makes no sense and raises questions about fairness and equity. But it's not likely to happen, because older people tend to vote, and no politician wants to run the risk of getting tagged as hostile to seniors.

There's also no reason to think the politics of the state and local tax will change anytime soon insofar as seniors go--even though a good case can be made that many states leave money on the table needlessly by exempting high-income retirees who could afford to pay more--and should from a fairness standpoint. In any of the states that have an income tax but exempt retirement income, a senior with $100,000 in Social Security and pension income pays no income tax, while a younger working single person earning far less would pay whatever the prevailing tax rate is in that state.

Exempting retirement income also creates a disincentive to work longer. Labor force participation beyond traditional retirement age is increasing as more workers struggle to achieve retirement security. A 66-year-old worker in these states pays full-boat taxes on her income, while a retiree of the same age pays nothing.

"I wouldn’t say the answer to that is to exempt all income over a certain age,” Wiehe says. “But it underscores how ludicrous it is to single out a certain kind of income and exclude it from taxes."

Morningstar columnist Mark Miller is a nationally recognized expert on trends in retirement and aging. He also contributes to Reuters,, and The New York Times. His book, Jolt: Stories of Trauma and Transformation, will be published in February by Post Hill Press. The views expressed in this article do not necessarily reflect the views of