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Are States With No Income Tax the Best Places to Retire?

Wednesday - 5/15/2013, 4:20pm  ET

When considering where you want to live in your retired years, states with no income tax have obvious appeal. But do they actually make the best places to retire? The answer will be different for every individual retiree, but factors like taxes certainly play a role in a smart retirement decision. Let's take a look at some of the financial aspects of retirement and how state income taxes affect the ideal choice for your retirement home.

State income taxes and you
As Fool contributor Dan Dzombak detailed last month, there are seven states with no income tax. Despite that shared trait, the states are otherwise very different. Most obviously, Texas, Florida, and Nevada are all warm-weather states that appeal to many retirees regardless of the tax situation. Alaska, South Dakota, and Wyoming are more attractive to those who like true winters, while Washington has a moderate climate. The states also differ vastly in terms of urban amenities. Texas and Florida have multiple large cities, while Seattle and Las Vegas dominate their respective states, and the remaining three states are largely rural.

But when you go beyond personal preferences to focus on money matters, the financial aspects of living in these states differ greatly. From a cost-of-living standpoint, Alaska is one of the most expensive states in the nation, making it more challenging for retirees on a fixed budget to make ends meet. Texas, on the other hand, ranks among the three most desirable states in terms of cost of living, according to a CNBC study from last year. Most of the other tax-free states rank in the middle of the pack, with Washington falling on the expensive side of average.

Moreover, even if you drill down specifically at state-level taxation, income taxes only tell part of the overall story. For instance, Washington collects the most of any state in the U.S. in combined sales and excise taxes on a per-person basis, and its gasoline and cigarette taxes are in the top 10 nationally. In Florida and Texas, property and sales taxes both rank fairly high, making up lost revenue on the income side.

When paying state income taxes makes sense
By contrast, when you look beyond states with no income tax, you'll often find more appealing combinations of traits for you, both financially and from a quality-of-life standpoint. Hawaii imposes some of the heaviest taxes in the country, but it consistently earns top honors on lists of best places to retire for its broad-based appeal. Arizona typically joins Florida among favored retiree landing spots, with a top income-tax rate of 4.54% not dissuading retirees from choosing the Grand Canyon State as a retirement destination.

In addition, some states that generally charge income taxes specifically exempt retirement income from Social Security and pensions, making them more attractive for retirees who get the bulk of their income from those sources. Pennsylvania and Mississippi go even further, exempting not only Social Security and pension benefits but also distributions from IRAs and 401(k) plans.

Finally, you need to consider going where services you want are offered. For instance, health-care real-estate investment trusts Senior Housing Properties , LTC Properties , and Health Care REIT , which recently acquired Sunrise Senior Living, all offer facilities in various places across the nation to provide for retirees who need health-care assistance in their living arrangements. But if your particular medical needs require specialists that are concentrated in particular cities, it's far more important for your health to be close to those specialists -- even if it means paying more in taxes.

Making the smart choice
In deciding where you want to live in your retirement years, states with no income tax are definitely worth considering. But you shouldn't ignore other important factors, both financial and otherwise. After all, you'll only retire once, and so it's important to make the most of the opportunity.

To retire with enough wealth not to have to worry about taxes, the best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.

This article was originally published as Are States With No Income Tax the Best Places to Retire?on Fool.com

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