Does Maryland Tax Retirement Income?
Planning for retirement involves many important considerations, and understanding the tax implications of retirement income is undoubtedly one of them. Taxes can significantly impact the amount of money retirees have available to support their desired lifestyle.
Many of our newly retired clients ask us the same question: Does Maryland tax retirement income?
In this blog post, we will explore the taxation policies in Maryland and specifically examine how retirees are taxed.
By delving into Maryland’s state income taxes and its treatment of various sources of income, we aim to shed light on the potential benefits and drawbacks that retirees may encounter. And by the end of this post, you’ll have the answer to the question: Does Maryland tax retirement income?
Maryland’s Taxation System
Does Maryland tax retirement income? To understand taxation in Maryland, it is essential to have an overview of the state’s and local tax structure.
Like many other states, Maryland relies on various taxes to generate revenue. The primary sources of revenue include income, sales, property taxes, and estate and inheritance taxes in certain instances.
However, this discussion will primarily focus on state and local income taxes.
Income Tax
Maryland uses a progressive tax system, meaning as a person’s taxable income rises, so does their tax rate. The state tax rates range from 2% for lower incomes to 5.75% for higher incomes.
Additionally, every county in Maryland, as well as Baltimore City, charges a local tax. This local tax is a percentage of your taxable income and varies by location, ranging from 2.25% to 3.20% in 2023. This local tax is an extra charge on top of the state tax rate and is often referred to as a “piggyback” tax.
Taxation of Retirement Income
Retirees receive income from various sources, including Social Security benefits, pensions, 401(k) plans, Individual Retirement Accounts (IRAs), and other sources.
Understanding how the state treats these different sources is crucial for retirees planning their finances.
On a side note, Maryland recently introduced possible credits for retirees, providing some tax relief, and we have a complete article on the subject here.
Does Maryland tax Social Security Benefits?
In Maryland, Social Security retirement benefits, including social security income, are not taxed. This exemption applies to all recipients in the state. All residents may subtract Social Security income on their Maryland tax return.
Maryland Pension Exclusion
Pensions received by residents are generally subject to state taxes.
Maryland allows for a pension exclusion, and the exclusion amount for 2023 was $36,200 (the 2024 Maryland Pension Exclusion amount is increased to $39,500). However, this pension exclusion does consider Social Security benefits, and the amount can be reduced or phased out completely. Marylanders can determine their potential pension exclusion using Maryland’s pension exclusion worksheet.
Also, retirees receiving a Military pension can subtract $5,000 from their taxes. However, individuals at least 55 years old on the last day of the taxable year can enjoy an increased deduction of up to $15,000 for their taxable income.
401(k) Plans and IRAs
Withdrawals from 401(k) plans and traditional IRAs are generally taxable in Maryland. Therefore, retirees must include the withdrawn amount on their return when they take distributions from these retirement accounts.
Maryland does consider 401k plans (along with 403b plans and specific other employer-sponsored retirement plans) as pension income, eligible for the pension exclusion mentioned above. However, withdrawals from Traditional IRA accounts do not qualify for the pension exclusion. Therefore, understand your exclusion eligibility before initiating any rollovers to an IRA.
Roth IRAs, made with after-tax dollars, are typically not subject to state taxes upon withdrawal as long as certain conditions are met.
Other sources of income, such as annuities, rental, and investment income, are generally subject to Maryland state tax. As with 401k plans, some annuity payments are eligible for the pension exclusion. However, please note that distributions from non-qualified annuities are not eligible for pension exclusion. These distributions are indicated with the code 7D on the 1099-R form.
Estate and Inheritance Taxes
Maryland is one of the few states in the U.S. that imposes both an estate and an inheritance tax. The estate tax is levied on the total value of an individual’s estate before it is distributed to heirs, with exemptions for estates valued below a certain threshold ($5 million for deaths occurring in 2023). The rates can range up to 16%.
On the other hand, the inheritance tax is applied to the value of property that the beneficiaries receive. The rate is typically a flat 10%, although immediate family members are usually exempt.
Is Maryland a Retiree Tax-Friendly State?
Retirees should consider potential benefits and drawbacks when planning their finances. Let’s explore some of them:
Potential Benefits
- Social Security Benefits Exemption: Maryland’s exemption of benefits from state taxes significantly benefits retirees. It allows individuals to retain a larger portion of their Social Security, contributing to their overall financial well-being during retirement.
- Military Pension Exemption amounts: The exemption of a portion of military pensions from Maryland state taxes can be advantageous for retirees who have served in the military. This can help preserve a greater amount of their income.
- Deductions and Exclusions: Maryland offers various deductions and exclusions, such as the pension exclusion for eligible retirees, that can help reduce the taxable portion of their income. These provisions can provide additional financial relief for retirees, potentially lowering their overall burden.
Drawbacks
- Taxation of Traditional Retirement Accounts: Maryland’s taxation of withdrawals from traditional retirement accounts, such as 401(k) plans and traditional IRAs, can result in retirees being taxed on those distributions. This can reduce the cash flow available for retirees to support their lifestyle.
- The Complexity of Tax Rules: Navigating Maryland’s tax rules can be complex, especially when considering various exemptions, exclusions, and deductions. Retirees may need professional assistance to ensure accurate reporting and maximize their tax benefits.
Conclusion
Navigating the complexities of Maryland’s tax laws on retirement income can be daunting. At RCS Financial Planning, we’re here to help you optimize your retirement strategy with our advanced planning strategies:
- Retirement GPS: Get precise guidance for your retirement journey.
- Retirement Stress Test: Ensure your plan’s resilience against historical scenarios.
- Tax Optimization: Strategize for tax-efficient distributions and Roth conversions.
- Life Hub: Consolidate and manage your retirement events in one place.
Secure your financial future with our expert guidance. Contact us today to schedule a consultation!
