While federal taxes apply uniformly, the way states tax 401(k) withdrawals can vary widely. Some states fully tax 401(k) distributions, while others provide deductions or exclude retirement income altogether. These differences can influence how much of your savings you keep and may even factor into decisions about when and where to retire.
A financial advisor can help you plan for taxes in retirement. Connect with a fiduciary advisor who serves your area.
Which States Tax 401(k) Withdrawals?
Among the states that levy income tax, many treat 401(k) withdrawals as ordinary taxable income. This means distributions are added to your annual earnings and taxed at your state’s applicable rate. Examples include California, New York, New Jersey, Oregon and Vermont. Retirees in these states typically pay the full state income tax rate on withdrawals.
Meanwhile, nine states do not tax 401(k) withdrawals at all because they have no state income tax. These states are: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
Other states take a more blended approach, offering partial exemptions for retirement income. In these states, retirees may qualify for deductions or credits that reduce the taxable portion of their 401(k) distributions. For instance, Pennsylvania exempts retirement distributions for people over age 59 ½, while Illinois, Mississippi and others also provide significant exclusions.
Some states, like Colorado and Michigan, apply age-based deductions that phase in or out depending on your circumstances. These policies create significant differences in after-tax income across the country.
| Tax Treatment | States |
|---|---|
| No state income tax | Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming, New Hampshire, Tennessee |
| Fully taxable | California, Hawaii, Idaho, Indiana, Kansas, Massachusetts, Maine, Maryland, Minnesota, Montana, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oregon, West Virginia, Vermont, Virginia |
| Partially exempt | Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, District of Columbia, Georgia, Illinois, Iowa, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Utah, Wisconsin |
Strategies for Planning for State Taxes on 401(k) Withdrawals
When planning for retirement, state taxes on 401(k) withdrawals can meaningfully affect how much income you keep. Since rules vary widely, strategies that account for where you live, how and when you withdraw funds and the mix of accounts you draw from can help shape a more tax-efficient retirement income plan.
Consider Residency and Relocation
For those with flexibility in retirement, moving to a state that does not tax retirement income can significantly reduce the tax burden on 401(k) withdrawals. States like Florida, Texas and Nevada offer complete relief from income tax, while others, such as Pennsylvania or Illinois, exempt most retirement distributions. Even relocating across state lines can noticeably affect after-tax income.
Time Withdrawals Strategically
Some states allow larger exemptions or deductions once retirees reach a certain age. For example, Colorado offers a $20,000 subtraction for retirement income starting at age 55, which increases to $24,000 at age 65. 1 A retiree who turns 65 in the coming year might delay a $30,000 withdrawal until after their birthday. By doing so, only $6,000 of that withdrawal would be taxable at the state level, rather than the full amount if taken the year before.
Spreading distributions over several years can also help avoid higher tax brackets.
Diversify Retirement Income Sources
Roth IRAs and Roth 401(k)s provide tax-free distributions at the federal level and are also excluded from taxation in many states. Combining Roth withdrawals with taxable 401(k) distributions allows retirees to better control their state-adjusted income. This mix can be used to minimize state taxes in years when other sources of income, such as pensions or investment gains, are high.
Coordinate Withdrawals With Other Income
Because most states start with federal adjusted gross income when calculating taxable income, the timing of withdrawals in relation to Social Security benefits, rental income or capital gains can affect the final state tax bill. Coordinating across income sources creates opportunities to stay within deduction thresholds, avoid phaseouts of credits and achieve a smoother tax profile year to year.
How State Income Tax Affects 401(k) Withdrawals
The difference in state tax treatment can translate into thousands of dollars of savings each year. In states with no income tax, like Florida or Texas, a retiree withdrawing $40,000 from a 401(k) would owe nothing beyond federal taxes. Compared with someone in a high-tax state, this could mean $2,000 to $3,000 more left in their pocket annually.
In a fully taxable state like California, a $40,000 distribution added on top of other income could fall into a 6 % to 9 % (or higher) marginal state rate for many retirees, meaning $2,400 to $3,600 in state taxes annually.
In partially exempt states, outcomes can differ. In Georgia, for example, taxpayers age 65 and older may exclude up to $65,000 of retirement income. 2 That means a 65-year-old withdrawing $40,000 could owe no state tax, effectively preserving what might otherwise have been taxed. Younger retirees (ages 62–64) can exclude up to $35,000, but if their withdrawals and other income exceed that, part of their distributions may still be taxable.
Bottom Line
State tax treatment of 401(k) withdrawals can have a significant effect on how far retirement savings stretch. The differences between fully taxable, partially exempt and no-tax states often amount to thousands of dollars each year. By understanding how your state handles retirement income and considering strategies such as timing distributions or diversifying account types, you can better manage the impact on your finances.
Tax Planning Tips in Retirement
- A financial advisor can help you structure your 401(k) withdrawals and optimize your income streams for tax efficiency. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Many retirees don’t realize that up to 85% of Social Security benefits can become taxable, depending on combined income. Drawing too much from pre-tax accounts or realizing large capital gains can push benefits into taxable territory. For example, coordinating withdrawals and using Roth or after-tax accounts to fill income gaps can keep total income below the thresholds that trigger taxation.
Photo credit: ©iStock.com/designer491, ©iStock.com/Jirapong Manustrong
Read the full article here
