Illinois does not tax pensions. The state’s 4.95 percent flat income tax does not apply to money from a qualified pension, a 401(k), a traditional or Roth IRA, Social Security, or railroad retirement benefits. That makes Illinois one of the more retirement-friendly states for income tax purposes, though wages, interest, dividends, and capital gains you earn in retirement are still fully taxable.
What Counts as Exempt Retirement Income
Illinois starts your state return with your federal adjusted gross income, then lets you subtract qualified retirement distributions to reach your Illinois base income. The subtraction lives in 35 ILCS 5/203 and covers nearly every common source of retirement money.1Illinois General Assembly. Illinois Compiled Statutes 35 ILCS 5/203 Base Income Defined The Illinois Department of Revenue confirms these categories are exempt:2Illinois Department of Revenue. Does Illinois Tax My Pension, Social Security, or Retirement Income?
- Qualified employer plans, including 401(k), 403(b), and 457(b) plans
- Traditional IRAs, Roth IRAs (including conversions), SEP-IRAs, and SIMPLE IRAs
- Federal, state, and local government pensions, including military retirement pay
- Social Security benefits (the portion taxed federally is fully subtracted)
- Railroad retirement benefits reported on Form RRB-1099
- State and local government 457 deferred compensation plans
- Retirement payments to former partners
- Redemption proceeds from U.S. retirement bonds
- Lump-sum distributions, including distributions of appreciated employer securities
The exemption follows the type of plan, not your age. Early withdrawals before 59½ still qualify for the Illinois subtraction, though the federal 10 percent additional tax on early distributions is a separate federal obligation that Illinois does not affect.3Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions Lump sums are treated the same as monthly checks. Rollovers between qualified plans generally never enter federal adjusted gross income in the first place, so there is nothing to subtract.
Inherited retirement accounts get the same treatment. The statute subtracts “all amounts” included in federal income under the qualifying sections, without distinguishing between the original account owner and a beneficiary.1Illinois General Assembly. Illinois Compiled Statutes 35 ILCS 5/203 Base Income Defined A surviving spouse drawing from an inherited IRA, or an adult child emptying an inherited account under federal beneficiary rules, subtracts those distributions on the Illinois return.4Internal Revenue Service. Retirement Topics – Beneficiary
Social Security and Railroad Retirement
The federal government taxes up to 85 percent of Social Security benefits for higher-income recipients. Illinois subtracts the entire federally taxed amount, with no income cap and no phase-out. Railroad retirement works the same way: it appears on your federal return, then comes back out on your Illinois return.
Retirement Income Illinois Does Tax
The exemption is generous, but it is not unlimited. One category that trips up retirees is the non-qualified annuity. If you bought a commercial annuity outside an employer plan or IRA, the earnings portion of your payments is not covered by the statute and stays subject to the 4.95 percent tax.
Illinois also applies its flat tax to other income a retiree might receive:5Illinois Department of Revenue. Income Tax Rates
- Wages, consulting fees, and self-employment income from part-time or freelance work
- Interest from savings accounts, CDs, and most bonds (U.S. government obligations are separately exempt)
- Dividends from stocks held in taxable brokerage accounts
- Capital gains from selling stocks, real estate, or other assets outside a qualified plan
- Net rental income from investment property
- The taxable earnings portion of a non-qualified annuity
Selling your home is a partial exception. Federal law lets you exclude up to $250,000 in gain ($500,000 if married filing jointly) from the sale of a primary residence you owned and lived in for at least two of the last five years.6Internal Revenue Service. Topic No. 701, Sale of Your Home Because Illinois starts with federal adjusted gross income, any gain excluded federally never appears on your Illinois return. Only gain above the federal exclusion is taxable in Illinois.
Claiming the Subtraction on Form IL-1040
Your retirement distributions land in your federal adjusted gross income first. You then take them back out on the Illinois return.7Illinois Department of Revenue. Step 2 – Income – IL-1040 Form Instructions The mechanics are straightforward:
- Enter your federal adjusted gross income on Line 1 of IL-1040.
- Enter your total eligible retirement income subtraction on Line 5. This is where the pension, IRA, 401(k), Social Security, and other exempt distributions come out of the base.
- Attach Schedule M to itemize retirement income details along with any other Illinois additions and subtractions.
You subtract the full federally taxed amount of the distribution, not just the portion that represents your own contributions. If retirement distributions are your only income, your Illinois tax liability can be zero. You still need to file a return if your federal adjusted gross income clears the Illinois filing threshold, even when no tax is owed.
Moving Into or Out of Illinois
If you moved during the tax year, you file as a part-year resident and claim the subtraction for eligible retirement income received while you lived in Illinois.
If you leave Illinois for good, federal law bars the state from taxing your retirement income once you are no longer a resident. Under 4 U.S.C. § 114, no state may impose income tax on the retirement income of a non-resident, and the protection covers qualified trusts, IRAs, 403(b) plans, 457 plans, government plans, and military retired pay.8Office of the Law Revision Counsel. Limitation on State Income Taxation of Certain Pension Income Illinois cannot reach back and tax a pension you earned in-state after you have moved away.
Moving the other direction, into Illinois from another state, brings you under the same exemption. Illinois does not tax retirement distributions based on where you earned the underlying income; the exemption follows the type of plan, wherever the work happened.