Real-world examples of state taxes impact on investment returns

Why state taxes quietly reshape your investment returns

State income taxes don’t make headlines like federal changes do, but they can quietly shave off a meaningful chunk of your returns every year.

For 2024, state top marginal income tax rates range from 0% (Texas, Florida, Nevada, and several others) to around 13% in California. New York, New Jersey, Minnesota, and Oregon also sit near the top of the list. You can see updated state rate tables on the Tax Policy Center and IRS state links.

Now layer that on top of federal taxes on interest, dividends, and capital gains. The combined hit can easily reach 30–40% for high earners in high-tax states. That is not a rounding error. Over 20–30 years, it’s the difference between retiring comfortably and wondering where your money went.

To make this concrete, let’s walk through real examples of state taxes impact on investment returns, using simple numbers and realistic 2024–2025 tax assumptions.

Example of state taxes impact: taxable bond fund in California vs Texas

Start with one of the cleanest examples of state taxes impact on investment returns: a taxable bond fund.

Imagine two investors holding the same national investment-grade bond ETF in a taxable account:

• Pre-tax yield: 5%
• Federal marginal ordinary income rate: 32%
• State marginal rate:
  • Investor A (California): 9.3% state income tax
  • Investor B (Texas): 0% state income tax

Both earn \(10,000 of interest on a \)200,000 position.

• Federal tax on interest: 32% of \(10,000 = \)3,200
• State tax on interest:
  • California: 9.3% of \(10,000 = \)930
  • Texas: $0

After-tax income:

• California investor: \(10,000 − \)3,200 − \(930 = \)5,870
• Texas investor: \(10,000 − \)3,200 = $6,800

That’s a 15.8% lower after-tax income stream for the California investor, purely due to state tax. Over 20 years, assuming reinvestment and the same yield, the gap compounds into tens of thousands of dollars.

This is one of the best examples of state taxes impact on investment returns because nothing else changes: same fund, same federal bracket, same yield. Only the state line matters.

Examples of state taxes impact on investment returns for municipal bonds

Municipal bonds are often marketed as “tax-free,” but the fine print is all about which taxes and which state.

In-state muni vs out-of-state muni

Consider an investor in New York City:

• Federal bracket: 24%
• New York State bracket: 6.85%
• NYC local tax: ~3.9%
• In-state New York muni fund yield: 3%
• National muni fund yield (mixed states): 3.2%

Interest on the New York-only muni fund is typically:

• Exempt from federal tax
• Exempt from New York State and NYC tax (because it’s in-state)

Result: The 3% yield is fully tax-exempt for this investor.

The national muni fund, by contrast, is:

• Exempt from federal tax
• Taxable at New York State and NYC levels, because much of the interest is from out-of-state bonds

So that 3.2% yield gets hit by ~10.75% combined state + city tax:

• State + city tax: 10.75% of 3.2% = 0.344%
• After-tax yield: 3.2% − 0.344% ≈ 2.86%

The lower-yielding in-state fund actually delivers the higher after-tax return. This is a textbook example of state taxes impact on investment returns where the “obvious” choice (higher nominal yield) loses once you account for state rules.

Investors in high-tax states like CA, NY, and NJ often find that state-specific muni funds make more sense in taxable accounts, while investors in no-tax states can simply chase the best national muni yields.

Capital gains: selling the same stock in different states

Capital gains feel simple: buy low, sell high, pay federal capital gains tax. But state rules turn this into another set of examples of state taxes impact on investment returns.

Imagine two investors, both long-term holders of a stock index fund:

• Initial investment: $100,000
• Value at sale: $200,000
• Long-term capital gain: $100,000
• Federal long-term capital gains rate: 15%
• State rates:
  • Investor A: California at 9.3% (capital gains taxed as ordinary income)
  • Investor B: Florida at 0%

Taxes at sale:

• Federal: 15% of \(100,000 = \)15,000
• State:
  • California: 9.3% of \(100,000 = \)9,300
  • Florida: $0

After-tax proceeds:

• California: \(200,000 − \)15,000 − \(9,300 = \)175,700
• Florida: \(200,000 − \)15,000 = $185,000

Same fund, same holding period, same federal rate. The California investor walks away with $9,300 less. That’s a real example of state taxes impact on investment returns that hits you the day you rebalance or cash out.

Now imagine doing this multiple times over a lifetime of investing, especially if you’re actively realizing gains. State capital gains tax becomes a running drag on your net worth.

Dividends and the state tax drag on high-yield portfolios

Dividend investors often focus on yield, payout ratios, and dividend growth. State taxes can quietly undo a lot of that work.

Consider two retirees in 2025 with dividend-heavy portfolios:

• Portfolio value: $1,000,000
• Dividend yield: 4%
• Annual qualified dividends: $40,000
• Federal qualified dividend rate: 15%
• State rates:
  • Investor A: Minnesota at ~9.85%
  • Investor B: Nevada at 0%

Federal tax on qualified dividends: 15% of \(40,000 = \)6,000.

State tax on dividends:

• Minnesota: 9.85% of \(40,000 ≈ \)3,940
• Nevada: $0

After-tax dividend income:

• Minnesota: \(40,000 − \)6,000 − \(3,940 = \)30,060
• Nevada: \(40,000 − \)6,000 = $34,000

That’s nearly \(4,000 more cash flow every year for the Nevada retiree. Over a 25-year retirement, ignoring growth and inflation, that’s about \)100,000 more spendable income from the same pre-tax portfolio.

This is one of the best examples of state taxes impact on investment returns for income-focused investors. It highlights why high-yield strategies are especially sensitive to where you live.

Asset location: same household, different states, different outcomes

Another subtle example of state taxes impact on investment returns shows up when you compare how investors in different states use asset location.

Take two high-earning professionals in 2024:

• Both max out a 401(k) and Roth IRA
• Both have $250,000 in a taxable brokerage account
• Both want a 70/30 stock/bond allocation
• Investor A: New Jersey resident
• Investor B: Tennessee resident (no wage income tax, and no broad state income tax on investment income)

If they both hold the same simple three-fund portfolio in every account (taxable and tax-advantaged), the New Jersey investor is needlessly paying state tax on bond interest and high-turnover funds.

The more tax-aware New Jersey investor instead:

• Packs bond funds and REITs into the 401(k)
• Uses low-turnover stock index funds and in-state muni bonds in taxable

The Tennessee investor, by contrast, has far more freedom to ignore state tax when deciding what to hold where.

End result: The New Jersey investor must think about state tax drag when designing asset location, while the Tennessee investor can focus mostly on federal treatment and investment strategy. Yet another example of state taxes impact on investment returns that’s invisible if you only look at pre-tax performance.

Moving states near retirement: a before-and-after example

One of the most powerful real examples of state taxes impact on investment returns is the decision to relocate before large withdrawals or asset sales.

Consider a couple planning to retire in 2026 with the following profile:

• Age: 60
• Traditional IRA: $1,200,000
• Taxable brokerage (mostly low-basis stock funds): $800,000
• Planned annual withdrawals: $120,000
• Current state: California (top marginal 9.3% bracket for them)
• Potential new state: Florida (0% income tax)

If they stay in California and withdraw $120,000 per year, a large portion of that IRA distribution is taxed at both federal and state levels. Over a 25-year retirement, the state tax on withdrawals plus realized gains can easily reach hundreds of thousands of dollars.

If they instead move to Florida before taking large IRA distributions and realizing major capital gains, the state income tax bill on those withdrawals drops to zero.

This is not theoretical. Many retirees intentionally move from high-tax states to no-tax or low-tax states (Florida, Texas, Nevada, Tennessee) to reduce the long-term tax drag on retirement assets. It’s one of the clearest lifestyle-driven examples of state taxes impact on investment returns.

For context on how state taxes fit into retirement planning, see the Social Security Administration’s state information pages at SSA.gov, which also link to state tax resources.

ETFs vs mutual funds: state taxes and capital gain distributions

A more technical example of state taxes impact on investment returns shows up in the structure of the funds you choose.

Mutual funds often distribute capital gains annually when they sell appreciated holdings. You owe federal and, in most states, state capital gains tax on your share of those distributions, even if you didn’t sell any shares yourself.

Many ETFs, by contrast, are designed to be more tax-efficient, with fewer taxable distributions. That difference matters more in high-tax states.

Imagine two investors in Oregon, both with $300,000 in actively managed U.S. equity mutual funds that distribute 8% of NAV as capital gains in a strong year:

• Capital gain distribution: 8% of \(300,000 = \)24,000
• Federal long-term capital gains rate: 15%
• Oregon state income tax rate: ~9.9%

Tax bill on the distribution:

• Federal: 15% of \(24,000 = \)3,600
• State: 9.9% of \(24,000 ≈ \)2,376
• Total: $5,976

If the same exposure were held in a broad-market ETF with minimal capital gain distributions, most of that $5,976 tax bill could have been avoided or at least deferred.

For an investor in a no-tax state, the state portion of that bill disappears. For someone in Oregon or California, it’s a very real hit to annual returns.

2024–2025 trends amplifying state tax effects

The recent environment has made these differences sharper:

• High nominal yields on bonds and cash-like instruments mean more taxable interest, which states treat as ordinary income.
• Market volatility has led to larger realized gains (and losses), making capital gains planning across state lines more important.
• Remote work has made state residency more flexible for high earners, increasing interest in tax-motivated moves.
• Several states have adjusted brackets and rates in the last few years, changing the math for long-term investors. You can track these changes through resources like the U.S. Census Bureau’s state finances data and state revenue department sites linked from the IRS.

All of this means the gap between high-tax and low-tax states, in terms of after-tax investment returns, is not narrowing.

Practical ways to manage the impact of state taxes

Seeing these examples of state taxes impact on investment returns is useful, but the real value is in how you respond. A few patterns show up across the cases above:

• Use tax-advantaged accounts aggressively in high-tax states. Put bond funds, REITs, high-turnover strategies, and actively managed funds in 401(k)s, 403(b)s, and IRAs when possible.
• Favor broad, low-turnover index funds in taxable accounts. This reduces both federal and state capital gains exposure.
• Consider in-state muni bond funds if you’re in a high-tax state and in a higher federal bracket. The state exemption can make a lower nominal yield more attractive after tax.
• Plan major sales around residency. If you’re already considering a move from a high-tax to a low-tax state, the timing of large capital gains events (selling a business, exercising stock options, liquidating a concentrated position) can have a major impact.
• Coordinate with a tax professional. State rules can be quirky: some states don’t tax Social Security; some give partial exclusions for certain types of interest or retirement income. A good CPA who understands multi-state issues can often point to very specific examples of state taxes impact on investment returns in your situation.

For educational background on taxation basics and how they interact with financial planning, the IRS maintains investor-oriented resources at IRS.gov, and universities such as Harvard publish personal finance and tax planning materials that are useful for deeper study.

FAQ: examples of state taxes impact on investment returns

How big is the typical state tax hit on investment returns?
For high earners in high-tax states, the combined state and local tax on interest and short-term gains can exceed 10% of the income itself. On a 5% bond yield, that’s roughly a 0.5 percentage point reduction in annual return, on top of federal tax. Over decades, that compounding drag is significant.

Can you give a simple example of state taxes changing the best investment choice?
Yes. A New York investor choosing between a 3% in-state muni fund and a 3.2% national muni fund might actually earn more after tax with the lower-yielding in-state option, because the in-state interest is exempt from both federal and state taxes. That’s a clean example of state taxes impact on investment returns altering which option is better.

Do zero-income-tax states completely eliminate tax on investments?
No. They eliminate state income tax on interest, dividends, and capital gains, but federal tax still applies. Some states also have property taxes, sales taxes, or other levies that indirectly influence your financial picture, even if investment income itself isn’t taxed at the state level.

Are capital gains always taxed at the same rate as ordinary income at the state level?
In many states, yes: long-term capital gains are simply treated as ordinary income. Some states offer partial exclusions or special treatment, but the default in places like California and New York is to tax capital gains at the same rate as wages. That’s why so many examples of state taxes impact on investment returns focus on large asset sales.

Does it ever make sense to move states purely for investment tax reasons?
For middle-income investors, moving purely for taxes is usually overkill. For high-net-worth investors facing large future capital gains or big IRA withdrawals, the lifetime difference can justify a move—especially if they already have non-tax reasons to relocate. The right decision depends on your numbers, your lifestyle, and your time horizon.

The bottom line: the best examples of state taxes impact on investment returns all tell the same story. State lines matter. Your ZIP code can change your effective return by half a percentage point or more every year. If you’re serious about building and preserving wealth, you don’t have to become a state tax expert—but you do need to respect the role your state plays in the math.