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Baseball, taxes and retirement destinations

New tax rules could affect retirees' relocation decisions

Mar 11, 2019 @ 10:20 am

By Mary Beth Franklin

My husband is a huge baseball fan. Me, not so much. But I always appreciate it when he forwards articles about his favorite pastime that are relevant to my passion for retirement planning.

Case in point: Bryce Harper's decision to sign a record-setting 13-year, $330 million contract with the Phillies was partially based on taxes, according to a recent article by Los Angeles Times sports writer George Skelton. Competing offers from the L.A. Dodgers and the San Francisco Giants couldn't overcome the burden of California's top state income tax rate of 13.3% compared to Pennsylvania's low flat rate of 3.07%.

Mr. Harper's agent, Scott Boras, said the tax savings from signing with the Phillies rather than a California team "could be almost a full year's compensation."

While most clients' income is a mere fraction of Mr. Harper's record-setting salary, keeping an eye on how taxes affect their net income can have a significant impact on their retirement lifestyle.

In the past, only a small percentage of Americans relocated in retirement, and the primary drivers have been better climate, a lower cost of living and proximity to family. But Mr. Harper's story made me wonder whether the recent federal tax law changes, which nearly doubled the standard deduction and capped the itemized deduction for state and local taxes at $10,000 year, will influence people's decision to relocate in retirement.

In 2018, the standard deduction for a married couple under age 65 is $24,000; that rises to $26,600 when both spouses are 65 or older. The standard deduction for a single individual under 65 is $12,000 and $13,600 if the person is 65 or older.

Therefore, it would make sense for a senior couple to itemize if their total tax deductions exceeded $26,600. With the total deduction for state and local income taxes and property taxes capped at $10,000 per year, a senior couple's deductible mortgage interest and charitable contributions would have to top $16,600 to choose itemizing deductions over the standard deduction.

Many residents of high-tax states such as New York, New Jersey and California pay well above the new $10,000 limit on SALT deductions. This year, as taxpayers file their 2018 tax returns, marks the first year that they are feeling the pain of the limited SALT deductions. And every year they remain in a high-tax state will cost them money in the form of higher state taxes compared to living in a lower-tax state.

For retirees who have paid off their mortgage or who live in a lower-tax states, choosing the standard deduction is a no-brainer. Millions of Americans may never itemize again.

That also means they will no longer be able to deduct their charitable contributions. Advisers should remind clients who are age 70½ or older that they can make direct transfers from their IRA to charities to satisfy part of their required minimum distributions each year. The donation reduces their adjusted gross income, which could lower their federal tax bill and possibly future Medicare premiums.

Even before the new tax law took effect, high-tax states in the Northeast were losing residents to other parts of the country, particularly to the warmer and lower-cost South. The Census Bureau's Current Population Survey released late last year shows the Northeast lost more than 350,000 residents to net migration between 2017 and 2018. The largest loser was New York, with a net migration of more than 190,500 residents, followed by New Jersey with a loss of more than 57,000 residents.

Where are they going? Of the approximately 600,000 people who left the Northeast, more than two-thirds — about 412,000 people — moved south. The top destination was Florida, which just happens to have no state income tax.

No-income-tax Nevada and low-income-tax Arizona also saw population spikes, partially fueled by an exodus of residents from high-tax California.

But before clients load up the moving van, they should review the overall tax picture of their potential new home, including property and sales taxes, and consider how states that have an income tax treat different forms of retirement income.

Seven states — Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming — have no income tax. Two states, New Hampshire and Tennessee, tax only dividends and interest. But states that don't tax income often make up the revenue shortfall with higher property and sales taxes.

Most states with an income tax offer some type of retirement income exclusion, whether exempting entire categories of income, such as pensions, or excluding a set amount of income each year. For details, see the latest Kiplinger retiree tax map. I have a soft spot for this annual wrap up of most and least tax-friendly states for retirees as I authored many of the reports during my 13-year tenure at Kiplinger's Personal Financial magazine.

Although the federal government taxes up to 85% of Social Security benefits, the majority of states exclude Social Security from state income taxes. Only 13 states tax some or all Social Security benefits including: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia.

As more and more retirees choose the standard deduction on their federal returns, where they live and how much they pay in overall state taxes could have a significant impact on their net retirement income.

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