Federal workers making retirement plans should consider whether the state where they live or plan to move taxes federal pensions or annuities. Federal employees fall under either the Civil Service Retirement System, the Federal Employees Retirement System, and the Organization Retirement and Disability System. Those retiring under the FERS may also receive Social Security checks.
States With No Federal Employee Retirement Tax
Federal employees contemplating retirement may want to consider the 10 states that do not tax federal retirement annuities or pensions as of 2011. In the South, these are Mississippi, Louisiana and Alabama, In the Midwest, Kansas, Illinois and Michigan do not tax federal pensions. In New England, only Massachusetts makes the list, and in the mid-Atlantic states New York and Pennsylvania do not have a federal retirement tax. There's also Hawaii, a nice place to spend the retirement years.
States With No Personal Income Tax
Federal employees may also consider retiring to states that have no personal income tax, especially if the retired spouse did not work for the federal government and is covered under a private pension system. As of 2011, the states without personal income tax were Florida, always a popular place to retire, Nevada, Alaska, New Hampshire, Texas, Tennessee, Washington, South Dakota and Wyoming.
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Federal retirement taxes are not the only taxes to consider when planning a place to live in retirement. Certain states also have inheritance taxes, which retirees may want to avoid if they want to leave as much as possible to their heirs. Of the states that do not tax federal retirement benefits, Hawaii has an estate tax for resident decedents on estates valued at over $3.5 million, ranging from 0.8% all the way up to 16% for those worth over $10.1 million. Illinois exempts estates under $2 million from tax. Kansas has two different types of estate tax, but has "sunset" provisions, depending on date of death. The "pick-up" estate tax ends in 2017 and the stand-alone estate tax ends in 2020. Louisiana has an estate transfer tax on estate valued at more than $60,000. Mississippi imposes a tax on estates worth more than $1 million. In New York, estates worth more than $1 million counting all exemptions are subject to tax. Pennsylvania's inheritance tax exempts the surviving spouse but taxes the inheritance of all lineal descendants such as children and grandchildren at 4.5 percent, and higher for other relatives or non-relatives. The other states that do not tax federal retirement income do not impose estate or inheritance taxes.
Other Taxes to Consider
Federal retirees should also consider the state sales tax, property tax rate and fuel taxes when considering relocation. According to the Retirement Living Information Center, "Many people planning to retire use the presence or absence of a state income tax as a litmus test for a retirement destination. This is a serious miscalculation since higher sales and property taxes can more than offset the lack of a state income tax. The lack of a state income tax doesn't necessarily ensure a low total tax burden." It lists the five states with the lowest local and state taxes based on percentage of income as Alaska, Wyoming, Vermont, North Dakota, and Hawaii. Of those five, only Hawaii specifically doesn't impose taxes on federal pensions or annuities.