The short answer is: Yes, Arizona taxes different types of retirement income. However, don’t let this prevent you from retiring in Arizona. Almost every state taxes retirement income in some capacity. As they say, life has only two certainties (death & taxes).
Compared to other states, though, Arizona is a fairly tax-friendly state to retire in and does not tax social security benefits. With this in mind, its tax rate is unlikely to put extra pressure on your golden years.
The taxes you pay in Arizona will depend on your retirement income. This is because the state taxes different income streams at different rates. For example, a real estate investor who plans to live off rental income and a former government employee who plans to collect a large pension will have very different tax filings come April 15th.
Most retirees fund their retirement income with a mix of retirement accounts, Social Security, and other assets. This is why speaking with a retirement planner from ARQ Wealth is so important. Our team is knowledgeable about the latest tax laws in Arizona and will be able to give you a complete picture of your financial planning.
With that in mind, let’s break down which income streams you can expect to pay taxes on in Arizona, according to the latest information from the Arizona Department of Revenue.
Retirement Income That Arizona Taxes
If you earn income in any of the following ways, expect Arizona to take a percentage.
Income from working a job (2.5% Income Tax)
If you plan on working a full or part-time job during retirement to help make ends meet then you can expect to pay a flat income tax rate of 2.5%. At just 2.5%, Arizona boasts one of the lowest state income taxes in the country—which is an attractive selling point for those nearing retirement.
Also, keep in mind that you only need to file income taxes if you earn over $13,850 (filing individually), $27,700 (filing jointly), or $20,800 (filing head of household). You must pay Arizona’s income tax even if you only plan on staying in the state for part of the year. Of course, if you do not plan to work to pad your retirement income then this income tax is irrelevant.
Income from retirement plans
You must pay taxes (2.5%) on all money that you withdraw from a 401(k), 403(b), or Individual Retirement Account. You must pay this tax even if you receive it from another state or inherit the fund from another family member. Arizona essentially treats this type of retirement income as regular income.
So, if you plan on taking IRA contributions or 401(k) withdrawals for your retirement income, you can expect to pay 2.5% in taxes.
Income from pensions
In Arizona, you must pay taxes on all money received from a pension.
Income from capital gains
You must pay taxes on all money earned from capital gains, which Arizona treats as regular income. However, you may deduct 25% of any long-term capital gains acquired after Dec. 31, 2011.
Retirement Income That Arizona Does Not Tax
Fortunately for retirees, there are quite a few income streams that Arizona does not tax. If you earn income in any of the following ways, then you will not need to pay taxes:
- Interest in US government obligations
- Social Security benefits
- Active duty military and National Guard pay
- Benefits, annuities, and pensions as retired or retainer pay of the US Armed Services
- Arizona does not have an estate or inheritance tax
If you plan to fund your retirement using any Social Security or any of these income streams then you can rest assured that Arizona will not require you to pay taxes on them. In particular, the fact that Arizona does not tax Social Security is particularly attractive for many retirees.
Other Taxes to Know About
There are other taxes that you should expect to pay when retiring in Arizona. For example, even though you don’t need to worry about it when filing your taxes, you should still factor sales tax into your financial planning.
Here are other Arizona taxes that you should know about:
- Sales Tax: Arizona has a sales tax of 5.6%. This puts the Grand Canyon state right in the middle of the pack, with a sales tax that isn’t as high as California (7.25%) but isn’t as low as Delaware or Montana (both of which do not have any sales tax at all). Again, you don’t have to worry about this tax when filing your taxes. However, you will be responsible for paying sales taxes anytime you buy something, which means it can significantly increase your cost of living throughout your retirement.
- Property Tax: Arizona’s average sufficient tax rate is 0.51%, according to data from SmartAsset. This is well below the 0.99% national average. However, keep in mind that your property tax rate will vary depending on home values and the county you live in.
- Estate Tax: Arizona does not require estate taxes, although you will still likely have to pay a federal estate tax.
- Inheritance Tax: Arizona does not have an inheritance tax, although you will still likely have to pay a federal inheritance tax.
It’s important to keep all of these taxes in mind when planning whether or not to settle down in Arizona for retirement. However, there are also a handful of tax benefits that come with moving to the Grand Canyon State.
Arizona’s Tax Credits
Arizona has several different tax credit programs. These programs allow you to donate money to notable causes and reduce your tax liability at the end of the year. These credits are either refundable or non-refundable, and non-refundable tax credits can be carried forward into future years.
- Credits for contributions to QCOs and QFCOs: You may claim a tax credit if you donate to a Qualifying Charitable Organization (QCO) or Qualifying Foster Care Charitable Organization (QFCO). If you make donations to any of these organizations then you can claim these tax credits at the end of the year to reduce your taxable income.
- Public School Tax Credit: You may claim a tax credit if you contribute to a public school in Arizona to support eligible activities, programs, or purposes. The maximum credit allowed is $400 (married, filing jointly) and $200 (single, heads of household, and married, filing separately).
- Credits for contributions to a Certified School Tuition Organization (STO): You can claim a tax credit if you contribute to an STO, which is an organization that funds scholarships for students to attend qualified private schools located in Arizona.
- Family Income Tax Credit: You may claim this credit if your income does not exceed the maximum income allowed for your filing status.
- Excise Tax Credit: You may claim an excise tax credit to compensate for increased excise taxes imposed by county governments. This credit depends on your income and is designed to assist disabled and low-income individuals.
- Property Tax Credit: You may receive a property tax credit if you meet all of these criteria:
- Paid property taxes or rent on a main home in Arizona during the tax year.
- Were 65 or older by December 31 of the tax year or received Title 16 Supplemental Security Income.
- Earned a total household income of less than $3,751 and the taxpayer lived alone, or the total household income was less than $5,501.
By taking advantage of the above tax credits, you can lower your taxable retirement income and pay a lower tax rate at the end of the year.
What Else to Know
Certain counties within Arizona allow their senior citizens to “freeze” the valuation of their property under the Senior Property Valuation Protection Option. This means you can stop your property from gaining value, which secures a stable property tax.
This option is only available for property owners who are over 65, are living in a primary residence, and have a total annual income under a certain threshold. For more information, check with your local county in Arizona.
Finally, many counties within Arizona also offer an Elderly Assistance Fund. This fund is designed to proportionately reduce the primary school district taxes paid by qualified property owners.
So, Should You Retire in Arizona?
Arizona has a fairly low tax rate of 2.5% on W-2 income, retirement withdrawals (401k, IRA, etc) pensions, and capital gains. This, combined with the fact that it does not tax Social Security retirement benefits, makes Arizona a very attractive state to retire in.
If you plan on using these forms of retirement income to fund your retirement then you may want to consider retiring in Arizona. On top of that, Arizona offers a fairly low state income tax as well as many credits that can help you lower your taxable income.
On the other hand, if you plan on using different forms of retirement income than the ones listed above, Arizona may not be the right choice for you. Additionally, there is more to consider than just your tax burden. You must also consider factors like the lifestyle that Arizona offers and its proximity to your friends and family.
If you’re interested in hearing more about how retiring in Arizona could improve your retirement planning, please schedule a consultation with a member of the ARQ Wealth Advisors team today.
