Smooth sailing in retirement? Not in Ocean State

An estate tax cut estimated to save taxpayers $18 million annually must make Rhode Island more attractive to wealthy retirees, right?
“Not really,” said Sandra Block, senior associate editor at finance magazine Kiplinger, which recently named Rhode Island the “least tax-friendly” state for retirees in the nation – again – despite a tax-code change aimed at making the Ocean State more attractive to affluent seniors.
“The change did help, because now only assets exceeding the threshold are taxed,” Block said. “But Rhode Island’s threshold is still low and it’s much lower than the federal threshold. If someone leaves their home it could exceed that amount. That is … a big reason retirees who are well off would consider living elsewhere.”
Before the new estate-tax overhaul goes into effect next year, anyone leaving an estate with Rhode Island assets worth more than $921,655 will be taxed on its full value, not just the amount over the threshold. That’s the so-called estate tax “cliff” reform advocates have been attacking for years.
The Rhode Island estate tax rate starts, and will remain, at 0.8 percent, rising to a maximum 16 percent for estates larger than $10 million.
While federal estate tax rates reach much higher, to a maximum of 40 percent, they only tax the marginal value above $5.34 million for tax year 2014, meaning far fewer Rhode Islanders would be affected by the federal tax than the state version.
To become more tax competitive, the General Assembly this past summer passed a bill creating a $64,400 credit toward the estate tax which, when it goes into effect, will effectively raise the state exemption to $1.5 million for those who die on or after Jan. 1, 2015.
That will actually make Rhode Island’s estate tax threshold higher than Massachusetts, where the threshold is $1 million, and not too far behind Connecticut, with a threshold of $2 million. In total, 20 states have an estate tax, plus another six have an inheritance tax. (New Jersey and Maryland have both.)
But unfortunately for Ocean State officials trying to keep wealthy seniors from decamping for more generous tax climates, Block said the estate tax remains just one facet of Rhode Island’s unfavorable retiree tax policy.
The bigger concern for most retirees, most of whose estates won’t owe tax, is that Rhode Island taxes not just assets when you die, but just about every kind of retirement income while you are alive.
“It is one of only a handful of states that tax social security up to 85 percent,” Block said. “Most don’t tax social security.”
Kiplinger also called out the state’s taxation of pension income as a negative for retirees.
And even though Rhode Island recently lowered its top income tax rate from 9.99 percent, Block added that the new top rate of 5.99 percent still kicks in at a lower level than most states.
Property taxes vary by town, but taken in aggregate, Rhode Island has the 11th-highest burden according to the Tax Foundation, which Kiplinger uses for the purposes of its rankings.
So if cutting the estate taxes doesn’t move the needle in making Rhode Island an attractive place to spend the golden years, what would?
“I think one thing that would make a difference would be exempting some retiree income from taxes,” Block said. “Some states exempt 100 percent of withdrawals from IRAs. That is what really distinguishes Rhode Island. There are no tax breaks for retirees, and that is unusual.”
It should be noted, of course, that there is more to retirement than avoiding taxes. A number of other publications rank states’ attractiveness to retirees based on factors that include nonfinancial considerations.
On these lists Rhode Island fares somewhat better.
According to Forbes.com, Rhode Island is the 10th-worst state to retire in, citing cost of living as the major drawback.
Bankrate.com, which takes into account everything from the health care system and crime to weather and taxes, did not include the Ocean State in either its top or bottom lists.
Robert J. Tyler Jr., vice president and wealth-management officer at The Washington Trust Co., said it’s difficult to say how the estate-tax change will affect retiree behavior, as estate planning usually happens over several years.
Especially when it comes to something as significant as moving to another state, those decisions are unlikely to be made after one General Assembly vote.
Looking further ahead, Tyler said the estate tax change could alter strategies on gifting assets that have appreciated to family.
When an asset that has gained significant value over time is given to a family member before the original owner dies, it is subject to capital gains tax, which is not the case if it is transferred as part of an estate after death.
Lowering the estate tax could make it advantageous to hold onto such assets, such as a piece of real estate, said Tyler, who nonetheless cautioned that everyone’s tax liability is unique and advice for one wealthy individual may not apply to another.
“Years ago people would trade off the capital gains rate for the estate tax rate when estate tax rates were much higher,” Tyler said. “Now as [estate tax] exemptions are higher, they can pass it along under the exemption and avoid both estate tax and capital gains.” •

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