Should You Relocate to Trim Taxes in Retirement?
NEW YORK – Relocating for retirement and trimming the budget line for taxes are among the many tasks pre-retirees and retirees have on their to-do lists. Many people consider checking off both items by moving to a state with low taxes or tax breaks that specifically benefit older residents. And these days, people affected by tax reform’s squeeze on the federal deduction for state and local income taxes (SALT) are feeling increased pressure to make such a move.
No doubt moving from a high-tax state to a low-tax state can produce savings. For instance, a taxpayer in California who pays the top state income tax rate of 13.3% can move to Florida and cut that tax rate to zero.
Yet a quick fix can be much more complicated than it seems. Yes, you’ll improve your bottom line, at least at first. But your overall tax savings may not be as great as you anticipated. Relocate to cities such as Dallas or Seattle and you could find higher property taxes cutting into your expected savings. In Texas, residents pay an average of $1,993 in taxes per $100,000 of assessed home value, which is on the higher end of property taxes nationwide.
And the tug of your old hometown may cost you, too. Will you end up with higher travel expenses weighing down your budget, as you fly back and forth to visit family and grandchildren in other parts of the U.S.? Will you actually be willing to put down roots in your new location, or will your spending increase as you maintain a second house or rental property in your previous home state? If you continue to earn an income in the state you leave behind, you’ll owe non-resident taxes, and you could be penalized if you don’t pay.
You’ll also need to keep on top of financial details that can add to your moving expenses. High-tax states, such as New Jersey and Connecticut, are making it more difficult to leave, imposing tax surcharges or tax prepayments on high-end homeowners who relocate. You’ll need to carefully document the establishment of residency in your new low-tax home state, from enlisting an entirely new network of health care providers to joining a local neighborhood group. Skip those steps and you could face additional taxes and penalties from your old state; authorities in high-tax states can be aggressive about investigating former residents to ensure they actually relocated.
“Paying close to 10% in state taxes was bad enough when it could be deducted. Now it’s even worse,” says Lyle Benson, founder of LK Benson and Co., a Towson, Md., CPA financial planning firm. “But you have to be really committed to changing your domicile, and it can’t just be done for tax purposes. You really have to cut ties with your home state. It can be a balancing act.”
Still, even for retirees in states with modest taxes who aren’t being hit as hard by the SALT deduction cap, moving can be financially beneficial. If you’re living off your IRAs and your pension, “you really get a bump up in pay” by relocating to a state with a lower cost of living, including lower taxes, says Robert Westley, a New York City certified public accountant and financial planner. And clients with sizable property taxes who can only deduct the $10,000 in SALT “are really feeling it,” he says, and considering a move. (See Kiplinger’s state-by-state guide to taxes on retirees.)
For John Lohse, 65, a public defender who lives in Rahway, N.J, the decision to leave his beloved New Jersey came down to a simple but dramatic calculation: Two months’ worth of property taxes alone would cover the property tax for a full year in Florida.
Lohse pays nearly $10,000 a year in property taxes on his New Jersey townhouse, valued at around $300,000. He and his partner are looking at buying a $200,000 to $250,000 home on the west coast of Florida, and they estimate paying $1,200 to $1,300 per year in Florida property taxes. Further shaving their costs, the couple will have no state income tax bill in Florida.
For tax year 2018, the couple’s accountant estimates the couple lost $23,000 in deductions because of the SALT cap, Lohse says. The couple plans to move to Florida by the end of next year.
“If we could afford to live in New Jersey in retirement, we would,” Lohse says. “This is an absolute money decision. Emotionally, I would stay in Jersey. I’m a New Jersey boy, born and raised, and I love it for a lot of reasons. But they get me enough on taxes here. The SALT deduction killed me. You just can’t afford to live in New Jersey anymore.”
Check the moving punch list
Financial planners say that they’re not seeing an exodus of clients from high-tax states just yet, because the law’s impact has yet to be fully felt. Tax laws are also subject to change. There are several bills in the U.S. House that would raise or eliminate the SALT deduction cap, though it’s unclear what action could result. Also, the cap is scheduled to expire with other provisions of the 2017 Tax Cuts and Jobs Act after 2025.
But if, like Lohse, you are serious about relocating, be aware of the tripwires that can make your move harder. You want to be sure the move is worth every penny. Before you box up your belongings and load up the moving van, review the following checklist of challenges to prepare for a move to a lower-tax state.
Item No. 1: A high-tax state may make it difficult to leave. In some cases, you’ll have to deal with tax prepayments or you’ll forfeit a state tax credit if you move. In New Jersey, what’s known as an “exit tax” is really an estimated tax payment on the profit from the sale of your home in New Jersey, which must be paid immediately upon selling the home, rather than when you file your income tax return, Westley says. “It’s a prepayment of the potential income tax due, and it’s possible the entire amount is refunded to the taxpayer,” he says. The tax, Lohse says, was the last straw for him.
Connecticut signed into law a revised “mansion tax” that goes into effect in 2020 and taxes proceeds from high-end properties at a higher rate. Sellers are required to pay a 2.25% tax on the amount of proceeds in excess of $2.5 million on the sale of their home; proceeds from homes that sell below that amount are taxed at a lower rate. If you stay in the state, you are eligible for a tax credit equal to the amount of tax paid at the 2.25% rate starting three years later, but if you leave, you don’t get the benefit, says Loretta Nolan, a financial planner in Old Greenwich, Conn. “It’s rewarding people who stay and demonizing those who leave,” she says.
Be sure to check your current state’s tax policies before considering a move, so you can be prepared for extra tax payments or extra paperwork.
Item No. 2: Be willing to commit to your new state. “You can only have one domicile, and it’s where you consider your home,” Benson says. If you don’t want to spend enough time in your new location and you are reluctant to make it your home, “it’s hard to make it work from a tax standpoint,” he says.
Besides needing to prove residency in your new location, living in two places can be costly. Let’s say you keep a house in Maryland and buy an inexpensive condo in Florida that you don’t enjoy spending time in beyond a few months in the winter. You would rack up a lot of expenses with carrying costs on both the house and the condo and the added travel expenses for going back and forth. Even if you sell your house and stay in hotels, returning to your home state frequently to visit friends and family can get expensive.
Before you move, spend time in the new location and consider whether you’ll be satisfied with the quality of health care and the culture and entertainment offerings. If you live in Maryland, for instance, and it’s important to be close to medical care at Johns Hopkins or the University of Maryland, you need to factor that into your decision. Investigate the transportation options in your new community. Visit outside of vacation season and stay for longer periods.
Michael Eisenberg, a principal with Squar Milner, an accounting and financial planning firm in Encino, Calif., confers often with clients thinking of relocating because of California’s high taxes. He suggests driving through the side streets of a prospective neighborhood to get a feel for actually living there. One client changed his mind about moving after noticing too many parked RVs in the driveways. Eisenberg also advises clients to be sure they’ll have a support system in place, with some family or friends nearby – “someone you could call upon if you really needed something,” he says.
Item No. 3: Be prepared to prove you really moved, particularly if you will have more than one home. Some states, such as California, are particularly aggressive in making sure you cut your ties if you moved to, say, Nevada, for the lower taxes but kept a second residence in California, Eisenberg says. You need to show you actually took up residence elsewhere. Register to vote, open a bank account, even keep receipts from your new hairdresser. The more you can document the ties to your new community, the more you can prove you really relocated, he says.
Some states will even examine details of how you settled in, Nolan says. She had a case where authorities did an inventory of how much artwork was hung on the walls of one home versus another. “They can drill down to that level,” she says.
Some high-tax states will consider you a resident if you spend more than half the year there, says Westley, who also is a member of the Personal Financial Specialist Committee of the American Institute of CPAs. In New York, a taxpayer is treated as a resident for income-tax purposes if he maintains a permanent home there and spends more than 183 full or partial days per year in the state, Westley says.
For example, if you move to a new home in Florida from New York but still work in New York and keep an apartment there, you may be considered a resident of New York for tax purposes if you are spending more than 183 days in New York. If you move away and don’t keep a home in New York, you’re not automatically in the clear, but your risk of being challenged is much lower, Westley says. Be sure you understand how the rules work in your old and new states.
Item No. 4: Look at the whole tax picture. In addition to state taxes, be sure to check whether local taxes are high, and research whether taxes and other expenses are on the increase in the state you are moving to. Check if the new state has death taxes, and if so, its rules, and be aware that you need to re-do your estate planning documents for your new state.
Also, if you are still earning income from a business based in your previous home state, you’ll need to file a nonresident tax return and pay taxes on the income. For instance, you’ll need to pay taxes on income from rental properties or an Airbnb. Income from partnerships and corporations can fall into a grey area and you’ll need to find out what you might owe, Benson says. “This does trip people up,” he says.
Item No. 5: Time your move carefully. Think in the long term so you only have to move once, Benson says. Your adult kids or other family members who live elsewhere are unpredictable – you could move to escape high taxes only to find you have grandchildren on the way in another state, which may lead you to move twice and spend far more than you saved.
But if it’s a more predictable event, say, you are expecting a deferred compensation payoff after your company has been sold, moving sooner rather than later could make a big difference for you financially, Benson says. Your payout could be taxed at your new state’s lower tax rate, potentially saving you thousands of dollars.
Running through this checklist may help you figure out whether you are ready to stay or go, but it’s not an easy decision particularly if you’ve been a longtime resident of your current hometown. Benson is working with clients who are on the fence. Both spouses are retired, with adequate investment income. They are considering moving full-time to Florida but struggling with whether they really want to be there for more than three months in the winter.
Moving to Florida will give the clients a significant break on Maryland property taxes. But they are looking at buying a $1 million house on Florida’s Gulf coast, which will have expensive carrying costs for upkeep and insurance. They still have family in Maryland, and they have been happy living there. “Those kinds of issues are stopping the move,” he says.
But for Jim Zerwekh, there’s no ambiguity. A media executive in his early sixties, Zerwekh settled his family in Florida nearly a decade ago and hasn’t looked back. Lower taxes are a major draw. Zerwekh once lived in Illinois, and he’s had job offers to move back there or to work in California. But the high taxes in those states are a major deterrent, and he says he thinks their state governments don’t deliver adequate services in return. “There has to be a price you put on paying taxes,” Zerwekh says.
Zerwekh and his family now live in Ponte Vedra Beach, Fla., where his youngest child is a senior in high school. Zerwekh says he has had no problem paying for a local tax hike to fund the schools, which he says are high quality. He’s near top health systems, universities, and pro and college sports teams. And as he winds down his working years, paying no state income tax is a major break for his budget. Moving to a low tax state is a good strategy for any pre-retiree bringing in income, he says.
Whether you are still working or fully retired, moving to cut your tax bill can save you money. But before you hire the movers, the key is making sure it’s the cost-cutting strategy for you.
2019 The Kiplinger Washington Editors; Mary Kane, Associate Editor, Kiplinger’s Retirement Report