Is My Pension Subject to State Taxes?

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A pension plan may provide certain tax relief from state taxes. But, not all states allow tax relief from pension plans. Your pension represents a retirement plan that is funded by your employer. You receive a benefit payment when you are ready to retire. Normally, pensions are subject to federal taxes. But, your state may offer you income tax-free pension payments.

Significance

State governments are not obliged to follow federal rules when assessing whether income tax is paid on money received by you. Your state may exempt all or part of your pension benefit from its own tax. An exemption is normally done by allowing a deduction on your state's tax return for the amount of money you received from your pension plan.

Benefit

Moving to a state with no income tax on pension proceeds means that you get more income in retirement that you can use for anything you want. Your cost of living may have just gone down, so you can engage in more of your favorite hobbies or life a better lifestyle.

Disadvantage

Just because your state provides you with a tax break on your pension income doesn't mean that it's automatically a good deal. If you move to a state where property taxes or other costs of living are higher, it may negate the benefit of living in that state. You could ironically end up with less retirement income due to a higher cost of living, even when your old home state assessed income tax on your pension payments.

Consideration

You must take into consideration all of the many variables involved in moving, if you want to lower your tax burden. While many states offer pension income on a tax-free basis, many do not. Consider taking your pension as a lump sum and converting it to a Roth IRA if your current state does not tax Roth IRA income. You pay income tax upfront, but all future withdrawals from your Roth are income tax-free. Not only does this eliminate the state tax on withdrawals but it eliminates the federal tax as well.

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