Arizona Retirement Taxes: What Retirees Really Pay
Retirees in Arizona benefit from favorable state taxes as well as the snowbird lifestyle
By Erin Itkoe
Many retirees settle in Arizona either part-time (as a snowbird) or full-time because of the warm weather and other amenities. As a retirement destination, this provides additional opportunities to socialize, which can make your post-work transition easier.
The cost of living is a huge issue to consider when looking at the pros and cons of living in Arizona. It’s generally more affordable than other popular retirement states. With moderate housing prices, lower transportation costs, and affordable food prices, the overall cost of retirement living is very reasonable.
Arizona is a tax-friendly state for retirees
But, before deciding where to retire, it’s also important to understand the tax treatments. With notably low taxes on retirement income, and no estate or inheritance tax, Arizona is one of the more tax-friendly states for older workers and retirees.
Arizona taxes most types of retirement income. In 2023, the state went from a progressive tax system to a flat tax rate effective for 2024 tax filings, a plan that might help to lower your tax bill. Employment income, investment income, pension income, and retirement distributions are all taxed at a flat 2.5% tax rate, regardless of your income level. Arizona is one of just 13 states with a flat individual income tax structure. Of the 13 states, Arizona has the lowest flat income tax rate.
Money withdrawn from pensions and retirement accounts is considered taxable income, with some exceptions, including railroad retirement benefits and retirement pay from the U.S. armed forces. Veterans can fully deduct military retirement pay from their state taxes. Residents who receive U.S. government civil service pensions and Arizona state or local government pensions are eligible for an annual tax deduction of up to $2,500. Arizona also taxes retirement income received from other states at the flat 2.5% rate.
Investment income is taxable in Arizona. Capital gains are subject to the same 2.5% flat tax rate as ordinary income, but some deductions are allowed. Taxpayers may deduct 25% of any long-term capital gain from assets acquired after December 31, 2011. Also, taxpayers may deduct the interest on income earned from U.S. government bonds.
Arizona is retiree-friendly with respect to Social Security benefits. Arizona does not tax Social Security retirement benefits, but you will pay federal taxes on a portion of your benefits if your total income exceeds certain thresholds. Arizona does not have a Medicare surtax.
As an example, let’s assume you are a 65-year-old who earns $60,000 annually. You earn $25,000 from Social Security, $20,000 from retirement distributions, and $15,000 from pension income; and a $2,100 over-65 exemption also applies. You would owe state taxes on only $32,900 of income for a tax bill of $822.50 (barring any other exemptions or deductions), since the social security portion is not taxable. This rate is lower than many other states, but you need to consider how it impacts your overall cash flow when you are on a fixed income.
Lower than average property tax and special senior programs help retired Arizona homeowners
Taxes apply to much more than just income. You also need to consider sales tax, property tax, and inheritance tax. Sales tax affects your overall cost of living and should be considered in your budget. Fortunately, Arizona’s cost of living is relatively low, even though the state sales tax is 5.6%. This does not include local city and county rates. Depending on local municipalities, the total tax rate can be as high as 11.2%, but the average combined state and local sales tax rate is 8.4%. Most tangible products are taxable in Arizona, while most services and food items intended for consumption are not taxable.
Property taxes can also be a major expense for retirees. Arizona has low property tax rates compared to other states. Additionally, Arizona offers property tax relief programs to help seniors. One example is the Senior Property Valuation Protection Program (“Senior Freeze Program”). This program helps seniors manage their housing costs, so they don’t have to worry about higher property taxes each year. This protects them from facing large tax bills in periods of housing market booms. The program freezes the taxable property value for qualifying seniors aged 65 or older. To qualify, you must meet certain income and residency requirements. You must go through the process of renewing this protection every three years.
Arizona does not have an estate or inheritance tax. This can result in major tax savings, depending on the size of your estate.
As you can see, there is a lot to consider as you evaluate your retirement options. There are both qualitative and quantitative items to consider. A financial professional can help guide you through this process. They can help you calculate the tax costs and understand how they impact your cash flow and overall financial plan. This is a big decision, so it’s important you work with someone who can guide you through all of the items to consider. You can find a licensed professional here. To find a licensed professional in Arizona, click here.
About the author
Erin Itkoe, CPA/PFS, CFP® is the Director of Financial Planning at Tarbox Family Office in Scottsdale, Arizona. She is also a member of the American Institute of CPA’s (AICPA)’s Personal Financial Planning Executive Committee, Tax & PFP Integration task force and serves as chair of the AICPA’s PFP Champions task force.