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 has a progressive taxation system in place, which implies that the tax rates progressively increase as the taxable income increases. The state’s tax rates span from 2% to 5.75%, with higher income brackets subject to higher rates.
Also, Baltimore City, including the Maryland counties, has implemented a local tax system. The local amount you owe is determined by calculating a percentage of your taxable income. Each county and Baltimore City set their specific local taxes between 2.25% and 3.20% for 2023.
Sales and Other Taxes
Maryland also imposes a sales tax on most goods and services, currently set at the state sales tax rate of 6%, which applies to most purchases made within Maryland. However, certain items, such as groceries and prescription drugs, may be exempt from the sales tax.
Although it does not directly impact income taxes, the cost of living in Maryland can still affect the financial considerations of retirees. This is because the overall cost of living influences expenses such as housing, transportation, and healthcare, all of which are significant components of retirement costs. Therefore, retirees must factor in these indirect costs when planning their finances. Maryland’s cost of living can also impact its attractiveness as a retirement destination for individuals looking to relocate.
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?
All Social Security retirement benefits, including social security income, are exempt from taxation in Maryland. Taxpayers who pay federal taxes on Social Security can subtract the taxed benefits from their state return.
Pensions and The Pension Exclusion – Subtraction
Pensions received by residents are generally subject to state taxes.
Maryland allows for a pension exclusion, and the exclusion amount for 2022 was $34,300. 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.
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.
In conclusion, this post answered the question: Does Maryland tax retirement income? Maryland’s tax system involves a mix of potential benefits and drawbacks. Understanding the nuances of Maryland’s tax system and seeking professional guidance can help retirees optimize their financial planning.
If you’re a retiree in Maryland or considering retirement in the state, it’s essential to consult with a financial professional or certified public accountant (CPA) who specializes in retiree taxation. They can provide personalized advice and help you navigate the complexities of Maryland’s laws, ensuring you make informed decisions regarding your retirement finances.
Remember, laws may change over time, so staying up to date with the latest regulations and seeking professional assistance can make a significant difference in your retirement planning.
