North Carolina's retirement income tax rules have certain specifics that retirees, or those approaching retirement, should take the time to fully understand.
These rules play a pivotal role in shaping the financial landscape of your retirement years, leading to astute decisions regarding financial management that can help maximize retirement investments and savings while minimizing tax obligations.
In This Insight
Overview of North Carolina's tax system
The State of North Carolina operates on a flat income tax system. This means that, regardless of income, everyone pays the same rate. As of 2020, the flat income tax rate stands at 4.75%. North Carolina also has a 4.75% state sales tax rate, and a max local sales tax rate of 2.75%. Counties within North Carolina can add on to this base rate, making the average combined rate around 6.99%. This sales tax applies to most goods and some services. While groceries are exempt from the state sales tax, they might still be subject to certain local taxes. Being aware of the extent of these sales taxes is crucial as they have a direct impact on the cost of living. Additionally, it's important to understand North Carolina's property tax laws. The state does not have a single statewide property tax rate. Instead, these rates are established at the local level and depend on location and the assessed value of the property. On average, the property tax rate in North Carolina is 0.70%, lower than the national average of 0.99%.
However, property owners aged 65 and over or who are totally and permanently disabled may qualify for a homestead exemption, reducing their property tax burden.
Understanding North Carolina's flat income tax system, average sales tax, and localized property tax rates is crucial for retirees planning to settle in the state.
Breakdown of North Carolina's retirement income tax
Because North Carolina operates under a flat tax system, seniors are not exempt from the 4.75% income tax, nor any of the statewide sales taxes. This rate applies to all taxable income, including distributions from retirement accounts such as 401(k) plans and individual retirement accounts (IRAs). However, Social Security benefits are completely exempt from income taxes. North Carolina also provides some solace to seniors in the form of extra tax deductions. Taxpayers who are 65 years or older qualify for a special standard deduction of up to $1,850 for Single filers or Heads of Household, and $1,500 (per person) for married filing jointly, married filing separately, and Surviving Spouses. Pensions in North Carolina are another common source of income for many retirees. The state has numerous rules and exceptions when it comes to taxing this form of income. Generally, if a taxpayer received the pension for services performed both within and outside of North Carolina, they will only owe state tax on the portion earned within the state.
However, certain federal, state, and local government pensions may be partially or entirely exempt from state income tax, so a qualified tax advisor should be consulted for specifics.
Specific tax provisions for retirees in North Carolina
North Carolina currently taxes all forms of retirement income, including public, private, military, and local government pensions, with the exception of Social Security benefits. It's also pertinent to mention that the state does not distinguish between in-state and out-of-state government pensions, both are considered taxable.
Other types of retirement income that are subject to the state income tax are dividends, interest, and capital gains. However, the taxation rates may vary depending on the source of income and your filing status. In North Carolina, a "Bailey Settlement" can come into play in certain pension-related tax situations. As a result of a court case, specific retirees may be entitled to exclude part or all of their retirement benefits from their taxable income.
This exemption applies to individuals who had five years of creditable service as former employees of the State of North Carolina, its local governments, and the federal government, including persons receiving these benefits as survivor beneficiaries.
Eligibility is determined by a combination of factors and it's advisable for retirees to seek professional tax advice to accurately assess their eligibility and potential advantages of the Bailey Settlement.
Despite North Carolina taxing most forms of retirement income, it completely exempts Social Security benefits, offering considerable relief for retirees reliant on this income.
How to plan for retirement income tax in North Carolina
Planning for retirement income tax in North Carolina begins with understanding the state's taxation laws for retirement income. Recognizing how your income from Social Security, pensions, and retirement savings accounts is taxed will help you develop an effective plan to manage your taxable income in retirement. A crucial element of retirement income tax planning in North Carolina comprises strategizing withdrawals from your retirement accounts. Assets such as pensions, 401(k)s, IRAs, and other retirement savings accounts are taxable as ordinary income at the state's flat rate.
This means that you have some level of control over how much tax you will pay each year in retirement, based on how much income you withdraw from these accounts. By being strategic with your withdrawals, you can manage your taxable income and potentially avoid moving into a higher tax bracket. Another vital part of planning for retirement in North Carolina is considering the impact of deductions on your taxable income. North Carolina allows for certain deductions which can lower your overall tax burden. For instance, former government employees and military retirees can deduct a portion of their qualifying retirement pay from their taxable income.
Understanding which deductions are available, and how they apply to your income, can make a significant difference when planning for retirement income tax in this state and help enhance your overall financial well-being in your retirement years.
Strategically managing withdrawals from retirement accounts, comprehending deductions, and understanding the state's taxation laws for retirement incomes are essentially the keys to efficient retirement income tax planning in North Carolina.
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