I had a conversation this week that I think a lot of federal employees need to hear.

The person I was talking with lives in Maryland, which is home to a huge number of federal employees. They also happen to live pretty close to the Pennsylvania border. We got to talking about taxes in retirement, and once we ran the numbers, the difference between the two states was big. Bigger than I think most people would guess.

Here’s why. And if you prefer the video version here is your link.

Not every state taxes retirement income the same way

Pennsylvania does not tax retirement income. Social Security, pensions, TSP, 401(k), and IRA distributions are all exempt once you’ve reached retirement age.

Maryland does tax it. So does Virginia. So do a lot of states.

This isn’t about high-tax states versus low-tax states, either. Take Illinois, where I’m based. Illinois has high tax rates overall, but it doesn’t tax retirement income. Pennsylvania works in a similar way. The question isn’t just “what’s my state’s tax rate?” It’s “what does my state actually tax once I retire?”

Every state is different, so I’d recommend you look yours up. But let me show you what kind of difference this can make.

The FERS retiree situation

This couple is planning on doing sizable Roth conversions for the first 8 to 10 years of their retirement. Between their FERS pensions, Social Security, TSP, and those conversions, their total income during that stretch will be at least $200,000, and potentially up to $350,000 or a little higher.

For anyone wondering, yes, this is a common scenario for many retired federal employees.

So we compared what they’d pay in state and local income tax living in Maryland versus Pennsylvania at both income levels.

	Maryland	Pennsylvania
$200,000 of total income	~$8,705	$0
Effective rate	4.4%	0%
$350,000 of total income	~$21,484	$0
Effective rate	6.1%	0%

These are approximate numbers based on a married couple, both 67, with $60,000 of combined Social Security and the rest coming from employer retirement plans. They’re meant to give you an idea of the difference, not to replace an actual tax return.

Look at that effective rate line. Pennsylvania: zero. Maryland: 4.4% at $200,000 and 6.1% at $350,000. That’s a big difference.

What that looks like over a retirement

At $200,000 of income, we’re talking about $8,700 a year. Over a 25-year retirement, that adds up to roughly $218,000.

But that’s not even the full picture, because it doesn’t factor in any return on that money. If you don’t need to spend that $8,700, that’s money you get to leave invested. Assume a 7% return, which is very reasonable over a 25-year time period, and that $218,000 becomes roughly $550,000.

That’s the difference just from where you live.

Now look at the $350,000 income level, where the difference is about $21,500 a year. To be fair, this couple wouldn’t be at that level every year. In their situation it would be for the 8-to-10-year window where they’re doing Roth conversions, and then their income would come down. But even if you only count those 10 years, that’s more than $200,000 in state tax that Pennsylvania wouldn’t have collected. Put that to work in the market and it’s a whole lot more.

Maryland stacks the taxes

Here’s part of why Maryland’s number is so high. In Maryland, you’ve got state income tax, and then you also have county and local income tax on top of it. Everybody wants some of your money.

The numbers above assume a county rate of 3.2%, which applies in the counties where most of Maryland’s population lives: Montgomery, Baltimore County, Howard, and Prince George’s. Rates across the state range from 2.25% to 3.30%, so your number could be a little lower or a little higher depending on where you live.

Maryland does offer a pension exclusion, but it’s not much. It gets reduced dollar for dollar by the Social Security you receive, and it doesn’t apply to IRA distributions at all. For a lot of retirees, it doesn’t move the needle.

If you’re close to a border, this is worth a hard look

I understand that moving is a big decision. If you live on the coast of California, which is one of the highest income tax states in the country, moving to a lower-tax state is a major change. You could easily save tens of thousands of dollars a year, but it would be a big move.

But if you’re a federal employee living in Maryland and you’re within driving distance of the Pennsylvania line? Man, that’s something I would consider. You may be able to keep the same friends, the same church, and be a short drive from the grandkids, and keep tens of thousands of dollars a year that would otherwise go to the state.

Same idea applies anywhere you’re close to a border. The state you live in matters. It can save you thousands, tens of thousands, and in some cases hundreds of thousands of dollars over your lifetime.

A few things to keep in mind

These numbers are estimates, and there are assumptions built into them. Your actual tax picture depends on how your income is split between Social Security, your pension, your TSP, IRAs, and any taxable investment accounts. If part of your income comes from a brokerage account, for example, Pennsylvania would tax that at its flat 3.07%, and the gap would narrow.

If you’re planning Roth conversions like this couple, also confirm exactly how your state treats them before you move or convert.

And of course, taxes are one factor among many. Cost of living, property taxes, healthcare access, and family all belong in the decision. But if you’re not tied down to where you live, don’t leave this one off the list.

The bottom line

Where you live in retirement can have as big an impact on your finances as how you invest. For federal employees near a state line, a move of just a few miles could be worth hundreds of thousands of dollars over a retirement.

If you’re near retirement and want help running these numbers for your own situation, including how Roth conversions and your state of residence fit together, schedule an introductory call here.

Brad Bobb, CFP®  |  Bobb Financial  |  www.bobbfinancial.com

This article is for educational purposes and is not individualized tax or investment advice. Figures are estimates based on stated assumptions. Tax laws change and individual circumstances vary; consult a qualified professional before making decisions.