A pension might be a major source of income for you when you retire. For this reason, you had better know the taxes you pay on your pension income. This will ensure that you have the information you need to decide how much personal savings you'll need. Since taxes reduce the amount of pension income you get, knowing this will be important.
Taxes are assessed by states and may be different from one state to the next. For this reason, it's not possible to say whether your pension will be subject to state taxes unless you understand your state's position on retirement income. Some states, such as Alabama, do not tax pension income. In these states, you'll have more income at retirement and won't need as much in the way of personal savings.
States with low or no income tax on pension income represent a tax haven of sorts at the state level. You get to deduct all or a portion of your pension income from your state income when filing your tax return. On top of that, you won't have to accumulate as much personal savings. This means that you may opt to save less for retirement, since you won't need as much money due to the fact that you're paying less or no state taxes on your retirement income, and you get to spend more of your money on other things during your working years.
A disadvantage with pension taxation at the state level may manifest itself when you move to a state that has a lower or nonexistent income tax on your pension but which has higher property taxes, sales tax or other taxes or cost of living than is higher than the state you were living in.
You should look for states that have low or no income tax when you retire and think about moving to those states. But, you must also take into account other factors which may offset the lower taxes you pay in retirement. Paying state taxes on your pension income may be the best choice if the cost of living is higher elsewhere. Additionally, you should accumulate a personal savings that will offset taxes you pay on your pension income. This personal savings may be in the form of 401k plan savings, IRAs or even annuity policy savings.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, et al.; 2007
- "The Calculus of Retirement Income"; Moshe A. Milevsky; 2006
- Retirement Living Information Center: Taxes by State
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