Moving to a state that has little or no income tax may not be a savings panacea.
That’s what financial professionals are telling clients who are fed up with high income tax rates in their home state and weighing an out-of-state move. They’re counseling clients to take an in-depth look at the possible financial and lifestyle ramifications before packing their bags.
Your money-saving move could end up being a costly one if you run afoul of state residency requirements.
That’s because clients trying to escape a state with high income taxes could experience higher property taxes, sales tax, insurance rates, and other cost-of-living expenses that minimize or negate the financial benefit they’re seeking.
“States with low or zero income tax are funding their government somehow,” says Rob Burnette, chief executive of Outlook Financial Center, an Ohio-based company that provides insurance services and asset protection solutions.
Here are several factors financial professionals say clients need to consider.
The overall tax picture. When helping clients make a relocation decision, financial advisors try to provide a full overview of how things could look in terms of income taxes, property taxes, sales taxes, and estate or inheritance taxes—major budgetary items people tend not to think about when making decisions on where to move.
Property tax rates, in particular, tend to catch people unaware, says Morgan Stone, a certified financial planner and president of Stone Wealth Management in Austin, Texas. He has had several clients move to his town to escape high income tax states, such as California, only to be shocked by high property tax rates. In Austin, a person could pay $18,200 in property taxes for a $1 million home, compared with $6,400 for the same value home in San Francisco, according to Smartasset.com’s property tax calculator.
Certified financial planner James Bogart recently ran an analysis to illustrate how much a relocating client who was buying an $800,000 home could expect in property taxes, effective income tax, sales tax, and estate or inheritance tax in six different areas of the country. The analysis also showed the estimated size of the client’s investment portfolio at age 90 based on these factors. The upshot: the state with zero income tax wasn’t the best move for the client’s portfolio. Rather, the client could amass roughly $1.4 million more by opting for the lowest property tax location instead.
This type of analysis is important, he says, because it shows that income tax can’t be considered in a vacuum. Other taxes can still have a “material impact” on overall financial well-being, even if a client maintains the exact same lifestyle, says Bogart, who is president and chief executive of Bogart Wealth, which has offices in Virginia and Texas.
Sources of income. While the common misconception is that if you move to a state with low or zero income tax, this rate will apply to all of your income, the analysis is more complicated if you earn income from multiple states, says Or Pikary, a certified public accountant and senior tax advisor with the Los Angeles office of Mazars, the global accounting and consultancy firm.
Say, for instance, you have a business that sells to customers in multiple states. Even if you move to Florida, which has no state income tax, you’re still required to pay taxes to the other states to the extent the income is sourced from there, he says. Rental property owners, regardless of where they live, also generally need to pay income tax to the state where the property is located. As a result, “your perceived income tax savings may be less than you think,” Pikary says.
Additionally, he suggests being cautious about state residency requirements if you’re moving to a lower tax state and maintaining ties to your old community. States have gotten more aggressive about doing residency audits—even more so since Covid began, he says. Your money-saving move could end up being a costly one if you run afoul of state residency requirements, he says.
Cost of living differences. Burnette of Outlook Financial offers the example of a recently retired client who planned to move from Ohio to Florida. His calculations showed that by moving to Florida she would need to work part time to maintain her lifestyle. This was true despite the income tax savings she’d achieve by moving.
Special deliberations for retirees. Some states, depending on your adjusted gross income, may not tax your income at all. So you may be in the same position—or worse—by moving to a zero income tax state once you factor in other taxes and a higher cost of living, Pikary says.
“It has always puzzled me when someone retires from a high income tax state and moves to a no state income tax state, such as Texas, when they have no earned income and then make a large real estate purchase that will have huge taxes,” says Stone of Stone Wealth.
“In reality, it should be the reverse—live and work in Texas and enjoy no state income taxes, then retire and move to a high income tax state when you have no earned income. Buy a big house there, and pay half the property taxes you paid in Texas,” he says.
Other considerations. Financial professionals say it’s important for clients to think through lifestyle implications and the potential associated costs. Those with school-age children should investigate the strength of the public school system and whether private school could be warranted and what the cost could be. Another consideration is whether your current state offers vouchers to attend private school and whether that’s a perk you’ll be giving up or gaining through a move, Pikary says.
People should also scope out the medical system in the new location and whether they will have to pay more for car insurance or home insurance generally, or wrack up additional costs due to provisions such as flood protection they didn’t previously need, says Bogart.
It’s also important for clients to determine whether they will still have access to activities they enjoy, such as skiing or sailing, and whether there may be extra costs involved. People also need to take into account their proximity to family and whether travel costs will increase.
“Many decisions in life are part financial, but also part emotional,” says Bogart. “We need to properly assess as many implications as possible.”
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