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Related topics: retirement, retirement planning, estate tax, real estate, Social Security

Where's the best state for you to retire? A lot will depend on your sources of income. For retirees, while relocating to an income tax-free state such as Florida or Texas may sound appealing, sometimes the best retirement destination is a state that imposes an income tax but offers generous exemptions for Social Security benefits, pensions and other types of typical retirement income.

Here are five of the most -- and least -- tax-friendly states for retirees. Just make sure that, before you move anywhere in retirement, you factor in local taxes, too. Municipalities can impose hefty property taxes or other assessments. Federal taxes? They'll be about the same no matter where you live.

Best: No. 1, Alaska

State income tax: None

State sales tax: None

Inheritance tax: No

Taxes? The Last Frontier State actually gives residents money for living there, distributed from its Permanent Fund, an oil wealth savings account administered by the state. This year, every man, woman and child who has lived in Alaska for at least one year received a 2009 dividend of $1,305. There's no income tax, no state sales tax, and only 25 municipalities even levy a property tax. Some municipalities impose local sales taxes of up to 7%, however.

Best: No. 2, Wyoming

State income tax: None

State sales tax: 4% (localities can tack on an extra 1%)

Inheritance tax: No

Retirees don't pony up much in taxes in the Cowboy State. Thanks to the abundant revenues that Wyoming collects from oil and mineral companies, residents shoulder the lowest tax burden of any state except Alaska, according to the Tax Foundation. Prescription drugs and groceries are exempt from state sales taxes. For most property, only 9.5% of market value is subject to tax, so a home worth $100,000 is taxed on $9,500 of assessed value.

Best: No. 3, Michigan

State income tax: 4.35%

State sales tax: 6%

Inheritance tax: No

The Great Lakes State offers generous retirement-income exemptions from state income tax. It does not tax Social Security or military, federal, state- or local-government pensions. Private pensions are exempt up to $45,120 for individuals and up to $90,240 for married couples filing jointly. (However, these private-pension exemptions are reduced by any public-pension deduction that you claim.) The state's flat-rate income tax is scheduled to gradually decline to 3.9% by 2015. Food and prescription drugs are exempt from state sales taxes.

Best: No. 4, Pennsylvania

State income tax: 3.07%

State sales tax: 6% (localities can tack on an extra 2%)

Inheritance tax: Yes

True to its Quaker roots, the Keystone State extends a friendly hand to retirees. It is one of the most generous states when it comes to offering income-tax exclusions on a wide variety of retirement income. Pennsylvania does not tax Social Security benefits or any type of public or private pensions. Nor does it nick distributions from 401k's, IRAs, deferred-compensation plans or other retirement accounts. Food, clothing and medicine are exempt from state sales taxes. But Pennsylvania is one of the few states that have both an inheritance tax and an estate tax.

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Best: No. 5, Colorado

State income tax: 4.63%

State sales Tax: 2.9% (localities can add their own)

Inheritance Tax: No

If the sheer beauty of the Rocky Mountains isn't enough to draw you to the Centennial State, its low, flat income-tax rate of 4.63% might. Taxpayers 55 to 64 years old can exclude a total of $20,000 of Social Security and qualified retirement income from state income taxes; those 65 and older can exclude up to $24,000. The state sales-tax rate is 2.9%, but local taxes can boost the combined rate to an average of about 7%. Food and prescription drugs are exempt from sales taxes.

Worst: No. 1, California

State income tax: 1.25% - 10.55%

State sales tax: 8.25%

Inheritance tax: No

The Golden State is a retiree's tax nightmare. Although Social Security benefits are exempt from state income taxes, all other forms of retirement income are fully taxed. Californians pay some of the highest income taxes in the U.S. State and local sales taxes can reach 10.5% in some cities and towns, although food and prescription drugs are exempt. Real estate is assessed at 100% of cash value, but taxes are capped at 1% of value.

Worst: No. 2, Rhode Island

State Income Tax: 3.75% - 9.9%

State Sales Tax: 7%

Inheritance Tax: No

Retirees face plenty of tax shoals in the Ocean State. Social Security benefits are taxed just like they are by the federal government. Rhode Island nicks virtually all other sources of retirement income, too. Starting this year, capital gains are taxed as ordinary income, eliminating the lower capital-gains rate in effect before 2010. The nation's smallest state also has one of the biggest statewide sales-tax rates -- 7% -- although it excludes food, medicine, some clothing and precious metal bullion. The Tax Foundation says Rhode Island's median real estate taxes are the fifth-highest in the U.S.

Worst: No. 3, New Jersey

State income tax: 1.4% - 8.97%

State sales tax: 7%

Inheritance tax: Yes

Its nickname may be the Garden State, but New Jersey is a thorny thicket for some retirees. Median real-estate taxes are the highest in the nation, according to the Tax Foundation. There are a few bright spots: New Jersey does not tax Social Security benefits and military pensions. It also allows residents 62 or older with incomes of $100,000 or less to exclude up to $15,000 ($20,000 for married couples filing jointly) of pensions, annuities and IRA withdrawals. Groceries, medicine and clothing are exempt from sales tax. The state imposes an inheritance tax on the transfer of real and personal property worth $500 or more, but bequests to family members are exempt.

Worst: No. 4, Vermont

State Income Tax: 3.55% - 8.95%

State Sales Tax: 6% (localities can add another 1%)

Inheritance Tax: No

There are no exemptions for retirement income in the Green Mountain State, except for Railroad Retirement benefits (which are exempt in every state). Out-of-state pensions are fully taxed. Vermont exempts medical devices and prescription and nonprescription drugs from its 6% sales tax. But it imposes a 9% tax on prepared foods, restaurant meals and lodging, and a 10% sales tax on alcoholic beverages served in restaurants. Real-estate taxes have two components: school property tax and municipal property tax collected by towns and cities where the property is located.

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Worst: No. 5, Iowa

State income tax: 0.36% - 8.98%

State sales tax: 6% (localities can add another 1%)

Inheritance tax: Yes

The Hawkeye State allows single retirees to exclude up to $6,000 of retirement-plan distributions from state income taxes, and married couples can exclude up to $12,000. It taxes a portion of residents' Social Security benefits, although it is in the process of phasing out the tax. Food and prescription drugs are exempt from state sales tax. Real estate is assessed at 100% of market value, and most property is taxed by more than one taxing authority, such as cities, counties and school districts. There is a small homestead tax credit for residents who live in-state at least six months of the year.