Originally published on The Street.
Financial planner Erin Itkoe breaks down Arizona’s flat tax, Social Security rules, and retiree-friendly provisions.
Arizona has long attracted retirees with its warm climate and relatively affordable cost of living. But for households deciding where to spend their retirement years, taxes can matter just as much as sunshine, according to Erin Itkoe, CPA/PFS, CFP, president of Luminescent Wealth Management.
In an interview, Itkoe, who is also a member of the American Institute of CPAs Personal Financial Planning Executive Committee, noted a significant 2023 Arizona tax change that greatly benefited retirees.
Below is a transcript of that interview, edited for brevity and clarity.
Arizona retirement taxes explained
Robert Powell: Many retirees settle in Arizona either part-time or full-time because of the warm weather and other amenities. But when you think about Arizona, you also need to think about the tax treatment.
Here to talk about that is Erin Itkoe. She is president of Luminescent Wealth Management. Erin, welcome.
Erin Itkoe: Thank you. I’m excited to be here.
Robert Powell: We’re glad to have you. Let’s start with the tax rates. What should retirees know?
Arizona’s flat income tax rate
Erin Itkoe: In 2023, Arizona moved from a progressive tax system to a flat tax rate.
The state now has a 2.5% income tax rate that applies to all income, including employment income, investment income, pension income, and retirement distributions. Everything is taxed at 2.5%, regardless of income level.
Robert Powell: So when we’re talking about retirement income, that includes distributions from IRAs, 401(k)s, and defined benefit pension plans.
Erin Itkoe: Yes, exactly, including pension income.
Investment income and capital gains
Robert Powell: What about investment income such as dividends, interest, and capital gains?
Erin Itkoe: Dividends and interest income are taxed at the 2.5% rate, as are capital gains. For long-term capital gains on assets acquired after Dec. 31, 2011, taxpayers may deduct 25% of those gains.
Military and government pension exceptions
Robert Powell: Let’s talk about some exceptions. Many retired military members move to Arizona. What happens with military retirement pay?
Erin Itkoe: Veterans can deduct their full military retirement pay from state taxes. They do not pay state income tax on that income in Arizona.
Robert Powell: What about U.S. government civil service employees?
Erin Itkoe: There is an annual deduction of up to $2,500 for federal civil service pensions. The same deduction applies to Arizona state and local government pensions.
Social Security taxation
Robert Powell: Many retirees collect Social Security. Is that taxed at the state level?
Erin Itkoe: Arizona does not tax Social Security retirement benefits. You may owe federal income tax on a portion, but there is no state tax.
Medicare surcharges
Robert Powell: Are there any Medicare surcharges at the state level?
Erin Itkoe: No. There are no Medicare surcharges in Arizona.
Property taxes and senior relief programs
Robert Powell: Let’s talk about total tax burden. What should retirees know about property taxes?
Erin Itkoe: Arizona generally has relatively low property taxes compared with other states. There are also property tax relief programs for seniors.
One example is the Senior Property Valuation Protection Program, often referred to as the Senior Freeze Program. If you qualify based on age, income, and residency requirements, the program freezes the valuation of your home for property tax purposes. That helps provide predictability for retirees managing cash flow.
Estate and inheritance taxes
Robert Powell: What about estate or inheritance taxes?
Erin Itkoe: Arizona does not have an estate tax or an inheritance tax.
Any downsides?
Robert Powell: You’ve covered a lot of positives. Any downsides?
Erin Itkoe: The summer heat can be intense. But residents adapt, and most buildings are air-conditioned.
The importance of planning
Robert Powell: For people considering a move, it sounds like consulting a financial professional makes sense.
Erin Itkoe: Yes. Anytime you’re making a significant financial change, you should consult a financial professional to evaluate how it affects your specific situation.
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About the authors
Robert Powell, CFP®, RMA®, is an award-winning financial journalist whose work has appeared in The Wall Street Journal, MarketWatch, USA Today, TheStreet, Investor’s Business Daily, Yahoo! Finance, and AARP. He is the editor and publisher of Retirement Daily on TheStreet and hosts the Decoding Retirement podcast. Powell also serves as editor-in-chief of the Retirement Management Journal and is a co-founder of finStream.tv. He was named a 2022 Robert N. Butler–Jack Rosenthal Age Boom Academy Journalist Fellow at Columbia Journalism School and received the 2021 RTDNA/NEFE Excellence in Personal Finance Reporting Award. Additionally, he teaches in the Financial Planning Association’s Online Elder Planning Specialist program.
Celine is a writer and editor with over 20 years of experience and has covered diverse news, features, academic/research, and legal topics. At TheStreet.com, Celine is a senior editor with experience across retail, stocks, investing, personal finance, technology, the economy, and travel.