Is Retirement Income Exempt From North Carolina State Tax?

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Your retirement savings allows you to stop working as you get older. North Carolina is a state which allows certain deductions for retirement income. However, these exemptions are not full exemptions. Instead, you receive a partial exemption, and only if certain conditions are met. You should understand these rules prior to reaching your retirement age.

Significance

  • You may deduct up to $4,000 from your tax return if you receive a state pension or retirement income. Private pensions or retirement income are subject to a $2,000 deduction. You cannot take a deduction if you do not withdraw money from your retirement account. Additionally, you do not receive the deduction if you draw retirement income benefits from an employer plan but continue working for the employer from which you are receiving the benefits.

Benefit

  • The benefit of a retirement income exemption is that you get to keep more of your income during retirement. While the deduction is small, this is more than you would otherwise get with no deduction. A government pension benefits the most since state and federal pensions are deductible up to $4,000. Married and filing jointly with a government pension allows you to deduct up to $8,000. Additionally, you may continue to work and receive the deduction from an IRA. The non-exemption rule only applies to employer plans.

Disadvantage

  • The exemption amount is small. While it is better than nothing, you still have to pay income tax on most of your retirement benefits. This may not be enough to help you avoid taxation of your social security benefits. Taxation of social security benefits occurs when one-half of your social security income and all of your other non-social security income exceeds $25,000 annually if you are single and $32,000 if you are married.

Consideration

  • Consider converting any traditional employer plans to a Roth plan. You will have to pay income tax on the entire amount of the conversion. Take advantage of the deductions available to you in North Carolina. After you pay tax on the conversion, North Carolina exempts all of your Roth income from income tax, so you won't have to worry about paying income tax on distributions from your retirement account.

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