The new tax law—the American Tax Payer Relief Act of 2012—is forcing retirees to take a closer look at their tax strategies in retirement and, for some, it means big changes in how they save, invest and draw down their resources.

First, there is a new top income tax bracket and a new top rate for capital gains and dividend income for individuals, estates and trusts.

Next, itemized deductions and personal exemptions are phased out for high-income taxpayers. (There’s a broader definition of who falls into that category than applies to the new tax rates.) And finally, everyone who earns wages or has self-employment income will contribute more to Social Security through their payroll taxes.

According to ATRA, there’s a new 39.6% tax bracket for single taxpayers with taxable income over $400,000 and married taxpayers filing jointly with taxable income over $450,000. Plus, for taxpayers in the new 39.6% tax bracket, capital gains and qualified dividends might be taxed at 20%, up from 15% in 2012. Itemized deductions are phased out for single taxpayers with adjusted gross income of more than $250,000 and married couples with adjusted gross income of more than $300,000. And the deduction for personal exemptions was reduced or eliminated for certain high-income taxpayers.

Given the new top tax rates for capital gains, dividends and other income, what are the best strategies now for saving for retirement and drawing down assets in retirement? In this edition of Retirement Adviser, MarketWatch’s Robert Powell spoke with three tax experts about retirement planning in the wake of the new tax law.

First, Frank Paré, an instructor in the personal financial planning program at the University of California at Berkeley and the founder of PF Wealth Management, said most taxpayers can breathe a sigh of relief in the wake of ATRA. The vast majority of taxpayers, retired or not, will be largely unaffected by ATRA.

Most pre-retirees, for example, who are contributing to retirement accounts such as an IRA, 401(k) or a Roth IRA have little about which to worry. “Their money is still going to be tax deferred, or tax free if the Roth conditions are met,” he said. “And so they’re not going to have to worry about the recent changes.”

High-income taxpayers who are in or nearing retirement, however, ought to examine how the new tax law will affect their retirement-income plans. “What will the tax changes mean for them in terms of their distributions, the amounts and so forth?” Paré asked.

In the wake of ATRA, high-income taxpayers have to consider whether distributions from their retirement accounts will put them into the highest income tax bracket. A taxpayer might think they are in a lower tax bracket, but the distribution from a retirement account could potentially put them in the highest bracket, he said.

For instance, if you’re single and your income is around $380,000 by the end of the year, it might not be worth taking a distribution of more than $20,000 from your IRA if you can avoid it. Income over $400,000 will be taxed at the 39.6% rate rather than the 35% rate.

“Now would be the time for retirees and would-be retirees to talk with their tax professionals and financial planners to see how all of these different moving parts are going to impact their distributions going forward,” said Paré.

And Mary Kay Foss, a director at Sweeney Kovar and an instructor for the CalCPA Education Foundation, added: “Generally retirees are in the same tax bracket as when they were working, but now they have the risk of perhaps being in a higher tax bracket,” she said.

Michael Jackson, a partner with Grant Thornton, and a leader of the firm’s private wealth services team, agreed that retirees and would-be retirees have to do what some describe as income-tax bracket planning, but they also have to worry about losing the value of some of their deductions.

“A lot of retirees are going to have to do a lot more planning for what income they want to have at each given year,” Jackson said. By managing their distributions the can avoid having their deduction be worth less or paying taxes at a higher rate, he said.

To be fair, Jackson said retirees and would-be need to coordinate their distributions so that they are tax efficient but not so much that you’re letting the “tax tail lead the dog.”

Paré also said most investors need not worry about paying the 20% tax on capital gains and dividends. But high income tax payers can use certain strategies and tactics to avoid being taxed at the highest rate. “In some regards it depends on the asset that they’re holding,” Paré said.

Owners of real estate, for instance, might consider a 1031 Exchange or “Like-kind” property exchange in order to defer capital gains. And owners of stock might consider offsetting their capital gains with capital losses.

“Taking some losses to offset the gains is always a very good idea,” said Foss. “(Some investors) tend to forget that they still have some (loss carry-overs) available to offset their gains. So, one good thing is to make sure that people are aware of what they have carrying over.”

Taxpayers might also consider deferring their capital gains and/or creating tax-efficient portfolios.

“I think looking at your overall investment portfolio and making sure you understand that the asset mix you have is what’s key here,” said Jackson. “We haven’t had a major shift in the tax law like this for some time. So, people made decisions on asset allocation based on the tax rates that were in existence prior to 2013. Now, that we have higher tax rates the efficiency of the portfolio needs to be redetermined.”

For instance, Jackson noted that with municipal bonds the tax-equivalent yield went up for someone who’s in the highest tax bracket. “So, with 3% yielding municipal bond where the tax equivalent yield was somewhere in the 4s is now well over 5%,” he said. “So, it may mean a little bit of a shift in how they structure portfolios in order to maximize return after taxes.”

Personal exemption phaseout

Each personal exemption you’re entitled to fully deduct (for yourself, your spouse, and your dependents) will reduce your taxable income by as much as $3,900. However, a tax law provision phasing out higher income taxpayers’ exemptions has been reinstated for 2013. The exemption phaseout starts once adjusted gross income (AGI) exceeds $250,000 (single), $300,000 (married filing jointly), $275,000 (head of household), and $150,000 (married filing separately).

For each $2,500 of AGI over the threshold, personal exemptions are reduced by 2%. So, if you’re subject to it, the exemption phaseout can increase your effective tax rate.

“On the front page of your tax return there are some deductions that are not affected by these limits,” Foss said. “In fact, they may be more beneficial given these limits.”

Foss said she doesn’t want to encourage divorce, but the alimony deduction is a good one. Other deductions that you can take on the front page of your tax return, according to Foss, include contributions to a retirement plan, medical insurance premiums for somebody who’s self-employed especially now that the IRS has said that if somebody is working past retirement age they can use their Medicare as a self-employed medical deduction. Plus self-employed taxpayers can deduct part of their Social Security tax on the front page of the return.

“So, these are some nice little deductions to be aware of,” said Foss.

Paré also noted that self-employed workers might consider restructuring the ownership of their company from an S corporation to a C corporation if their company is profitable. An S corporation is a pass-through entity that might be creating a lot of income. “By simply going to a C corporation they have some control with respect to their personal income,” Paré said. And that could be a huge benefit with respect to income and deductions on the front page of a tax return.

However, the decision to conduct business as a C corporation, S corporation, limited liability corporation or partnership should be made in consultation with experts who understand the intentions of and the impact on each of the business owners, Jackson said. “There are many instances where continuing to operate in pass though form makes a lot of sense,” he said after the roundtable.

Itemized deduction limitation

Along with any deduction for personal exemptions you’re entitled to, you may claim either itemized deductions or a standard deduction, whichever is larger. As you plan for 2013, however, consider whether you will be subject to the newly reinstated limitation on itemized deductions. Like the personal exemption phaseout, this limitation essentially increases the effective tax rates paid by affected individuals, the experts noted.

The limitation applies to taxpayers with AGI over a threshold amount: $250,000 (single), $300,000 (married filing jointly), $275,000 (head of household), or $150,000 (married filing separately). Basically, deductions are reduced by 3% of the amount by which AGI exceeds the threshold. However, deductions for medical expenses, investment interest, casualty and theft losses, and gambling losses are not subject to the limitation. And you can’t lose more than 80% of the itemized deductions that are affected.

“It’s basically a stealth tax,” said Jackson. “It’s another tax over and above the 39.6% tax bracket that some of taxpayers may hit along with other taxes (such as the Medicare surtax) that are going to be coming into play for 2013.”

So, are there ways to avoid this or plan around it?

“Again, the biggest thing is planning for your income levels because it’s not a deduction-based limitation,” said Jackson. “It’s based on your income. So, the more income you have the more susceptible you will be to losing some of those itemized deductions. The best strategy might be to restructure how you get your income.”

Paré agreed. “The real point here I think is given the changes that have taken place now is the best time to start talking to a tax professional,” he said. “Oftentimes individuals get into this sort of automatic, it is what we’re going to do. It’s every year we do it this way and there’s no real reason to change, but I think now, if ever, is perhaps the best time for them to engage someone to say ‘OK, let’s look at how we can shift this income or shift the way we’re doing our business in order to take advantage of some of these changes.’”

2013 Tax Rates & Brackets

Taxes, as many know, are among the biggest expenses people face in retirement. So it should come as no surprise that many retirees and would-be retirees ponder the thought of moving to a tax-friendly state.

But which are the most tax-friendly states? Well, it’s not an easy question to answer according to Kathleen Thies, a state tax analyst with CCH, a Wolters Kluwer business. States that have high personal income-tax rates might have low property tax rates and states with low personal income-tax rates might have high property tax rates.

And so the end game for those looking to find the most tax-friendly state is to review all their sources of income in retirement including earned income, Social Security, pensions, and unearned income; all the different types of taxes they might face in retirement including personal income, sales, property and the like; and their overall tax burden, Thies said in an interview.

For instance, those who depend less on Social Security and more on earned income in retirement might consider moving to a state with lower or no income-tax rates. Others who rely heavily on Social Security, by contrast, might consider moving to a state that doesn’t tax such benefits.

“People think they will move to Florida, or Texas, or Nevada and they won’t have any income tax,” she said. “But you have to remember that every state is a business and they need to create revenue. So if they aren’t doing it through income tax they will get it some other way, such as sales or property taxes.”

To be fair, taxpayers who contemplate retiring to one state or another or who contemplate retiring in place also have to calculate whether deducting certain taxes—income, sales, and property—on their federal tax return will make a difference on their overall tax burden.

“It’s so difficult to say which is the most tax friendly state because there are so many variables for each individual,” said Thies. “Overall, it’s a case-by-case basis.”

So what then are the key taxes seniors should assess when evaluating the financial implications of moving or staying put? According to Thies and CCH, they include the following:

State taxes on retirement benefits

Seven states do not tax individual income—retirement or otherwise, CCH said in a release. Those include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Two other states—New Hampshire and Tennessee—impose income taxes only on dividends and interest (5% for New Hampshire and 6% for Tennessee for 2012 and remain the same in 2013), CCH said.

Click here or on the image above to see a full PDF of how states tax various sources of retirement income.

In the other 41 states and the District of Columbia, CCH said, tax treatment of retirement benefits varies widely. For example, some states exempt all pension income or all Social Security income. Other states provide only partial exemption and some tax all retirement income.

States exempting pension income entirely are Pennsylvania and Mississippi. States exempting a portion of pension income include: Arkansas, Colorado, Delaware and New York. States generally taxing pension income include: Arizona, California, Minnesota and Rhode Island. (See pdf chart for additional details.)

“Looking at states that don’t tax individual income tax is good place to start when thinking about which state to retire,” said Thies. “There are reasons why so many people move to Florida. Much of it is the weather but some of it is the favorable tax treatment.”

Thies also said taxpayers should keep an eye on the funded status of their state and city pension plans. Those with underfunded pension plans, for instance might be forced in the future to raises taxes or reduce government services, or both.

The Pew Charitable Trusts has two reports on the health of pensions for states and cities. For instance, Connecticut, Illinois, Kentucky, and Rhode Island were the worst among the states, with pensions funded under 55% in 2010, according to one report. And in four cities—Charleston; Omaha; Portland, Oregon; and Providence, Rhode Island—pension systems were more poorly funded than those in Illinois, which at 51% was the lowest-funded state, according to another Pew report.

Read A Widening Gap in Cities.

Read The Widening Gap Update: States are $1.38 Trillion Short in Funding Retirement Systems. Read those reports to learn which other states and cities are most at risk of raising taxes, cutting services, or both.

In general, Thies said, there’s been so much uncertainty at the federal and state levels that the time to drill down on which might be the most tax-friendly state for you is when you’re ready to sell your home. “We generally don’t hear about people picking up and move just for the favorable tax treatment,” she said. Instead, other factors play a role including whether a person has friends and family in a new locale.

States announcing changes to income tax for retirement plans

A handful of states announced changes to income tax for retirement plans in 2012. According to CCH, those include:

Georgia: The personal income retirement exclusion amount has been capped at $65,000 for taxpayers 65 years of age or older and $35,000 for certain taxpayers between ages 62 and 65—for tax years beginning on or after Jan. 1, 2012.

Kentucky: At the end of 2012, The Kentucky Blue Ribbon Commission on Tax Reform proposed a reduction in the individual income tax pension exclusion from $41,110 to $30,000 and implemented a dollar-for-dollar phase out for income over $30,000.

Maine: In 2012, a law was enacted to limit the income tax deduction for certain retirement benefits for tax years beginning after 2013. This raises the deduction from $6,000 to $10,000 (reduced by the total amount of the taxpayer’s Social Security benefits and Federal Railroad Retirement benefits). The deduction is also expanded to include all federally taxable pension income, annuity income and individual retirement account (IRA) distributions, except pickup contributions for which a deduction has been allowed.

Michigan: The deduction for pension benefits for senior citizens is curtailed based on the taxpayer’s birth year and household resources. Currently, this deduction is limited by a dollar amount, but no other limitation applies. Specifically, for persons born before 1946, the deduction for pension benefits is unchanged (see pdf chart). However, for persons born in 1946 through 1952, the deduction for pension benefits is limited to $20,000 for a single return and $40,000 for a joint return. And after that person reaches age 67, the pension benefits deduction is no longer applicable, but the taxpayer is eligible for a deduction of $20,000 for a single return and $40,000 for a joint return against all types of income. A third set of options is available for taxpayers born after 1952, when they reach age 67.

Screening states in or out based on how they tax income is a good place to start, but Thies also noted that much could change in how states raise revenue in the future. For instance, she said some states are starting to lower personal income-tax rates this year, but increase sales tax rates. Massachusetts and Nebraska are two such states that have proposed lowering personal income-tax rates and raising sales tax rates.

Decreasing personal income-tax rates and increasing sales tax rates is a way to relieve the burden on the income tax side and put more money in the pockets of consumer in hopes of stimulating the economy. “It’s a way of collecting taxes tax on the back end,” Thies said. “I expect that this will be a trend that will continue and it will be interest to see how much traction it will get.”

Retirees will certainly benefit in states that follow this trend. Instead of being taxed up front on their personal income, retirees can choose when to be taxed and by how much. “People can regulate their spending” said Thies.

Fourteen states tax Social Security

While some states tax pension benefits, only 14 states impose tax on Social Security income, according to CCH. Those include Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia. These states either tax Social Security income to the same extent that the federal government does or provide breaks for Social Security income, often for lower-income individuals, CCH said in its release.

Retirees can rule in or out certain states to which to retire based on whether and how they tax Social Security. After all, Social Security represents on average 36.5% of all types of income for all retirees and 17.9% for those retirees in the upper income quintile. But they should review that list annually, Thies said.

That’s because many states are moving away from taxing Social Security. “It’s something to look out for,” she said. “But every year it seems like we get one more state that does away with taxing Social Security to the same extent that the federal government does. What happens on the pension income side, however, is another story.”

Thies noted that many would-be retirees and retirees often think they are leaving a high-tax state for what they think is a low-tax state only to find out that they were wrong. “People tend to think the grass is always greener on the other side,” she said. But if you are a high-end wage earner with lots of unearned income you might want to move to a state that also taxes dividends and interest.

Still, one shouldn’t let the tax tail wag the retirement state dog. Retirees and would-be retirees should contemplate nontax factors as well before deciding where to live, Thies said. “You also need to think about family responsibilities and care of elder parents and relatives,” she said. “There are lots of things to consider, taxes being just one of them.”

State income-tax rates

In addition to state taxes on retirement benefits, other taxes that seniors should consider when evaluating the financial implications of where they may to retire include state income-tax rates, CCH said.

For example, income-tax rates also can have a significant financial impact on retirees in determining where they want to live and can vary widely across the country, CCH said.

“As some retirees will face higher federal income taxes, they may look more closely at states with lower or no income-tax rates as one way to help offset their overall tax obligation,” said Thies.

While seven states have no income tax and two tax only interest and dividend income, several have a relatively low income-tax rate across all income levels. For example, the highest marginal income-tax rates in Arizona, New Mexico and North Dakota are below 5%.

Some states have a relatively low flat tax regardless of income, with the three lowest: Indiana (3.4%), North Dakota (3.99%) and Pennsylvania (3.07%) for 2013.

State and local sales taxes

Forty-five states and the District of Columbia impose a state sales and use tax (only Alaska, Delaware, Montana, New Hampshire and Oregon do not impose a state sales and use tax), CCH said.

States with a state sales tax rate of 7% include Rhode Island, Indiana, Mississippi, New Jersey and Tennessee, CCH said. California has a state sales tax rate of 7.5%.

According to CCH, local sales and use taxes, imposed by cities, counties and other special taxing jurisdictions, such as fire protection and library districts, also can add significantly to the rate. Given that, you ought to look at the combined state and local sales tax when looking for a state to call home in retirement.

For instance, Tennessee (9.44%), Arizona (9.16%), Louisiana 8.87%), Washington (8.86%) and Oklahoma (8.67%) have the highest combined state and local sales taxes according to a new report from the Tax Foundation.

And the five states with the lowest combined state/local rates greater than zero are Alaska, Hawaii, Maine, Virginia and Wyoming, according to the Tax Foundation.

And five states have no statewide sales tax, according to the Tax Foundation: Alaska, Delaware, Montana, New Hampshire and Oregon. Of these, Alaska and Montana allow cities and towns to levy local sales taxes.

Read State and Local Sales Tax Rates in 2013.

State and local property taxes

While property values have declined over recent years in many areas, that has not necessarily been the case for property taxes, CCH said. “However, many states and some local jurisdictions offer senior citizen homeowners some form of property tax exemption, credit, abatement, tax deferral, refund or other benefits,” CCH said in its release. “These tax breaks also are available to renters in some jurisdictions. The benefits typically have qualifying restrictions that include age and income of the beneficiary.”

For the record, in 2010, the residents of New York, New Jersey, and Connecticut paid the highest state-local tax burdens in the nation, according to the Tax Foundation. These are the only three states where resident taxpayers forego over 12% of income in state and local taxes.

Residents of Alaska, who have consistently been the least taxed state for nearly three decades, again paid the lowest percentage of income in 2010 at just 7%, the Tax Foundation said in its report. The next lowest-taxed states were South Dakota, Tennessee, and Louisiana.

Read Annual State-Local Tax Burden Ranking (2010)—New York Citizens Pay the Most, Alaska the Least.

Thies said property taxes represent a large and growing portion of a retiree’s expenses, especially if they own a large home. So retirees often must face the decision of living in place, downsizing but relocating to a lower property tax rate municipality not far from where they might already live, or relocating to a municipality with low property tax rates. “We do that property tax rates go up every year,” said Thies. Yes, many retirees want to stay in familiar surroundings but they really need to consider whether they need to live in the same house as when they were raising a family. “Property taxes can really affect retirees living on a fixed income,” Thies said. “It’s a difficult to decision to make because many people are tied to their homes emotionally. But it may cost you a lot more than you realize.”

To be sure, this is a classic between-a-rock-and-hard place issue. If a retiree ages in place, their property taxes will in fact rise. But if they move, even to a low property tax municipality, they might find that their overall tax burden is unchanged or worse, higher.

State estate taxes

Estate taxes also can influence where seniors want to retire. Rules vary from state to state as well as from federal estate tax laws. For example, 18 states impose a tax on estates valued below the $5.25 million federal threshold for 2013 ($5.12 million for 2012); only Delaware, Hawaii and North Carolina use the federal exclusionary amount. However, three states have no estate tax at all—Kansas, Oklahoma and Arizona.

Thies said she doesn’t see state estate taxes being a major factor for average Americans deciding where to retire. “People who have estate tax issues are at the top end,” she said. “They are in a different echelon.”

Indeed. “The American Taxpayer Relief Act of 2012 brings more clarity on the federal level that only estates above the $5 million mark indexed for inflation will be subject to the federal estate tax,” James Walschlager, an estate planning analyst at CCH said in a release. “However, the threshold in some states can be below $1 million for state estate taxes, which can impose additional planning challenges.”

Most states follow federal estate tax and would have seen a windfall to state coffers had the estate tax sunset to the pre-Bush era maximum 55% tax rate on estates over $1 million. However, even though that didn’t happen, some states have decoupled from federal estate tax law over the past several years as a way of holding on to tax revenues. In many of these states, residents can expect to pay taxes on estates well below the $5.25 million federal threshold for 2013 ($5.12 million for 2012).

“States that have stayed with the federal estate tax law, assuming it would be returning to the lower exclusion amounts, may now reconsider,” Walschlager said.

According to CCH’s release, states currently following the pre-Bush era estate tax provisions include: Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Rhode Island and Vermont as well as the District of Columbia.

Only Delaware, Hawaii and North Carolina follow the federal estate tax exclusion threshold. A few other states have enacted their own estate tax law separate from federal law. These include Connecticut, Oregon and Washington, as well as effective Jan. 1, 2013, Maine. Ohio repealed its stand-alone estate tax and has now recoupled with the federal estate tax law effective as of 2013.

Four states and the District of Columbia also allow domestic partners to file joint tax returns, CCH said in its release. This allows the partners to be recognized under their state’s estate tax laws and thereby enables the surviving spouse to avoid paying any taxes on the decedent’s estate.

Three states have no estate tax at all. These are Kansas, Oklahoma and Arizona, CCH said.

In addition to estate taxes, eight states also collect an inheritance tax, CCH said. “This is a tax on the portion of an estate received by an individual. It is different from an estate tax, which taxes an entire estate before it is distributed to individual parties,” CCH said. “These states are Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee ‒ which is phasing out its inheritance tax in 2015. Assets transferred to a spouse are exempt from the inheritance tax, and some states exempt assets transferred to children and close relatives.”

For more estate tax issues, read CCH Says Latest Tax Law Brings Some Certainty Back to Estate Tax Planning, But Decisions Remain.

So, really, there are no tax-friendly states per se—but there are plenty of states that might be friendly for you, if you’re willing to crunch the numbers.

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.