The state of Illinois is facing its own budgetary reality as lawmakers enter their final weeks in Springfield: $6.5 billion in unpaid bills, a $130 billion pension gap, and credit ratings that are still just above junk-bond status despite an income-tax boost last summer. That makes it an outlier in the Midwest, a state that can’t seem to manage its finances while its neighbors prosper. However, its tax structure is vastly different from theirs, a fact that members of both parties have long decried but which has remained unchanged.
J.B. Pritzker’s campaign is the latest to suggest that the state’s revenues be aligned with those of its neighbors, and that would be a significant change. He’s pushing to modify the state’s constitution to allow a graduated income tax instead of the mandated flat tax, after years of nonserious debate. If that happens, Illinois’ tax structure will be closer to those of neighboring states.
However, there are two additional forms of taxes that our neighbors use—ones that have been brought up repeatedly—that appear to be too noxious to consider.
In some way, all of Illinois’ neighbors tax retirement income (as does the federal government). Illinois is one of only three states with an income tax that does not apply to public and private pensions, 401(k) withdrawals, annuities, Social Security payments, and IRA withdrawals. If it did, a new report released last week by the nonpartisan Civic Federation of Chicago advised that Illinois enact a tax on retirement income, which the group estimates could raise more than $2.5 billion next year.
Laurence Msall, president of the Civic Federation, highlighted that the group’s idea isn’t a “stand-alone” proposal that would need to be implemented alongside a robust budget.
“If you don’t have to, no one wants to add any new taxes,” he remarked. However, he went on to say that the decades-old notion of exempting retirement income from taxation appears to be out of date. “Is it true that not taxing retirement income keeps people from moving to Illinois?” Msall explained. “The Census tracts appear to indicate that people are fleeing Illinois.”
Indeed, according to census data, the state has lost over 88,000 net people in the last four years, with more than a third of the drop occurring in the last year alone.
However, AARP Illinois state director Bob Gallo believes that serious consideration of a tax on retirement income will drive even more retirees out of the state.
“Our concern when this comes up… is not to solve the state’s fiscal problems on the backs of one group of individuals who did not create the problem in the first place, who in their retirement did not plan for this to come out of their retirement income, and who do not have the opportunity or elasticity in their income to make up the difference,” Gallo said.
In 2015, AARP conducted a poll of state residents over the age of 50 on the topic. Nearly 90% of people were against the concept. In a 2013 study conducted by the Simon Institute at Southern Illinois, 74 percent of respondents said no, but 60 percent said yes to a tax on retirement income over $100,000, compared to only 39 percent who said yes to service taxes.
Retirement income was included in Illinois’ first income tax, which was enacted in 1969. Retirement income was partially exempted two years later, and then entirely exempted in 1972. Though there had been concerns about losing money in the early days of the exemption, real discussions of reverting to the previous system rapidly proved politically untenable.
Senior citizens are a well-known voting bloc that can be counted on, and they are an important demographic to target. Both Gov. Bruce Rauner and candidate Pritzker agree on this point: no discussion of taxing retirement income, regardless of the possible revenue bump, is acceptable.
According to a recent analysis by the Civic Federation, Illinois should expand its sales tax to include a list of 14 service categories, the same category of services that Wisconsin taxes. Illinois presently taxes just a small number of services, albeit the majority of them—12 out of 17 according to the Federation of Tax Administrators—are classified as utilities and hence subject to separate taxation. Only Indiana, out of the five states that border Illinois, does not now tax services.
Jason Stein, research director for the nonpartisan Wisconsin Policy Forum, said he understands how difficult it is to propose new taxes on services—a “tax swap” was proposed in 2006 to reduce property tax burdens, but it ultimately failed—but once the sales tax is in place, “14 cents on a latte” tends to “flint under the radar.”
“If you ask a homeowner how much property taxes they paid last year, they’ll probably tell you immediately away,” Stein said. “Unless they’re keeping track, they wouldn’t know how much they paid in sales taxes.”
The case for taxing services is based on the changing nature of the economy: rather than spending primarily on goods, households are now spending more on services or services that deliver goods. The Tax Foundation, a nonpartisan think organization based in Washington, D.C., has recommended that governments adopt a broader tax base by extending sales taxes to services on numerous occasions.
Last spring, as leaders in the Illinois Senate attempted to broker a deal that would end the two-year political stalemate in which Illinois operated without a proper budget, the question of taxing certain services like laundry and dry-cleaning, pest control, security services, tattoos and piercings was on the table. However, the services were removed from the so-called “Grand Bargain” in the middle of discussions, and the deal fell through nevertheless.
Rauner was open to taxing “non-essential” services like charter jet flights, interior decoration, and marina towing during his first gubernatorial campaign in 2014. However, since Democrats and some members of his own Republican party pushed through a tax hike to end the budget impasse, Rauner has become a skeptic of any upward tax tweak.
Meanwhile, a Pritzker spokesman noted that whenever the candidate mentions opposing “regressive” taxes, she means an enlarged sales tax on services.
Do I have to pay taxes on a non-qualified annuity?
The amount you put into the annuity will not be taxed. The growth, however, will be subject to regular income tax. Furthermore, the IRS requires that you take the growth first when making a withdrawal, which means you will incur income tax on withdrawals until you have taken all of the growth. You’ll start getting funds tax-free from the principal, or basis, once the growing component has been depleted.
Are retirement annuities taxable in Illinois?
Your Retirement Annuity Is Taxed All GARS benefits are exempt from state income tax under Illinois law, but your benefits are subject to federal income tax.
Which of the following is true regarding taxes on nonqualified annuities?
Which of the following statements about nonqualified annuities taxes is correct? Premiums are not tax-deductible throughout the annuity pay-in period, but interest is tax-deferred until redeemed. The accurate response is that premiums are not tax deductible, but interest is.
What retirement income is taxable in Illinois?
Retirement Income: Illinois is one of the states with the highest tax burdens for retirees. It is, however, the only Midwestern state that exempts all 401(k), IRA, and pension income from taxation. To be tax-free, pension and 401(k) income must come from a qualifying employee benefit plan.
Benefits from Social Security: Benefits from Social Security are not taxed in the Prairie State.
Inheritance and Estate Taxes: Estates worth more than $4 million in Illinois are subject to an estate tax.
What retirement income is taxed in Illinois?
Almost all retirement income, including Social Security retirement payments, pension income, and income from retirement savings accounts, is tax-free in Illinois. However, the state has among of the country’s highest property and sales taxes.
Which part of non-qualified payments is taxable?
When money is withdrawn from a non-qualified annuity, however, no taxes are required on the principle. Only earnings and interest are subject to income taxes. If you bought your non-qualified annuity after August 13, 1982, the IRS’s “last-in-first-out” policy will apply to your distributions.
The exclusion ratio is a computation used by the IRS to determine whether portion of a non-qualified annuity withdrawal is taxable. The length of the annuity, the principal, and the earnings are used to calculate this ratio.
The exclusion ratio will take into account the owner’s life expectancy if a non-qualified annuity is set up to pay them for the rest of their lives. The goal is to spread the principal and revenues out throughout the life of the owner. All payments made after that time period are taxed as income if they live longer than their assessed life expectancy.
If your predicted life expectancy is 85 years, the exclusion ratio will determine how much of each payment from your non-qualified annuity will be deemed taxable earnings until you reach that age. All annuity distributions after the age of 85 are considered taxable income.
The withdrawals from your annuity are tax-free if you bought it with money from a Roth IRA or Roth 401(k) account rather than a standard IRA or 401(k) account.
How are non-qualified brokerage accounts taxed?
Qualified investments are accounts that are most frequently known as retirement accounts, and when money is invested into the account, it receives certain tax benefits. The following are some of the advantages of contributing to a qualifying investment account:
- Contributions are deductible from taxable income in the year they are made.
- Contributions and investment earnings can be deferred until they are withdrawn as taxable income; and
- By putting these funds into a qualifying account, the owner can postpone paying taxes until the year after they turn 70.5, when they must begin taking Required Minimum Distributions (RMD).
Accounts that do not obtain favorable tax treatment are known as non-qualified investments. In any given year, you can invest as much or as little as you desire, and you can withdraw at any moment. Money you put into a non-qualified account is money you’ve already earned from other sources of income and paid income tax on.
You only pay tax on the realized gains when you withdraw money from these accounts (i.e. interest, appreciation etc). The cost basis of a non-qualified account is equal to the amount of money you put into it. You are not taxed on the cost basis when you withdraw it because you have already paid income tax on it.
Stock appreciation is the difference between the value in your account and the cost basis. For example, if you invest $100, you will have made a profit of $10 after a year. Your non-qualified account now has a balance of $110, with a cost basis of $100 and an appreciation of $10.
So, what is the difference between qualified and non-qualified accounts? Essentially, it comes down to two factors: taxation and flexibility. I’d like to give you a couple of instances.
Consider a person who was about to retire. This individual had never dealt with a financial advisor in their professional life. They put money into their 401(k) with zeal, contributing the maximum amount each year. All of the assets were placed in a qualifying account at the time of retirement.
In other words, they converted their 401(k) to an Individual Retirement Account (IRA) and were ready to begin living off their 401(k) funds. This person had approximately $2 million in their IRA, which was a great accomplishment for their career! Now, the individual is considering spending $65,000 in 2016 to construct a garage for personal use.
Without any other significant investment accounts, the individual simply thought they would utilize money from their IRA to pay for the garage. To get the whole $65,000 for the garage, the individual would have to withdraw a lot more than that, because they would have to pay taxes on every dollar they took out.
If the individual had also been saving in a non-qualified investment account during their working years, they would have been able to withdraw funds from that account without having a significant impact on their 2016 taxable income.
**
Consider another person who could be interested in converting a Roth IRA. They wanted to conduct a Roth conversion since it would cut their taxed income for the year. A portion of the individual’s IRA was converted to a Roth, and the amount converted was taxed. The user now has a second savings account from which they will be able to draw funds at any time in the future. In the same way that a non-qualified account has money that has previously been taxed, a Roth holds money that has already been taxed. **
“Do I need both qualified and non-qualified accounts?” you might wonder. That’s a great question to pose to your financial counselor. In most circumstances, I recommend balancing your qualified and non-qualified investing accounts for the future. You’ll have a lot more alternatives and flexibility in retirement if you plan ahead.
* This information is provided for educational purposes only and is not intended to provide particular advice or recommendations to any individual.
Consult a knowledgeable specialist to discover what is appropriate for you.
There is no method that guarantees success or protects against failure.
This information is not meant to be a replacement for personalized tax advice.
We recommend that you speak with a certified tax professional about your individual tax concerns.
** This is a hypothetical scenario that does not apply to any specific situation. Your outcomes will differ.
Is a non-qualified account taxable?
4 Nonqualified plans are ones that do not qualify for ERISA’s tax-deferred advantages. As a result, when income is recognized, deducted contributions to nonqualified plans are taxed. In other words, before the money are contributed to the plan, the employee must pay taxes on them.
Are retirement accounts taxed in Illinois?
Qualified employee benefit plans, such as 401(K) plans; an Individual Retirement Account (IRA) or a self-employed retirement plan; and the federally taxed portion of Social Security benefits are not taxed in Illinois.
Is Illinois a tax friendly state for retirees?
Social Security benefits and income from most retirement plans are tax-free in Illinois, which is good news for retirees. Furthermore, the state’s flat income tax rate of 4.95 percent is relatively low.
The bad news is that property taxes in Illinois are particularly high for retirees. Illinois has the second-highest statewide median property tax rate in the US, at $5,413 per year for a $250,000 home and $7,578 for a $350,000 home. A homestead exemption of up to $5,000 ($8,000 in Cook County), the option to “freeze” a home’s assessed value, and a tax deferral scheme provide some relief for qualifying seniors.
Illinois has high sales tax rates as well. With an average combined state and local sales tax rate of 8.83 percent, the state ranks eighth in the nation. The rate might be as high as 11 percent in some areas! Clothing and consumables are also taxable (1 percent state rate; extra local taxes may apply).
Illinois also imposes an estate tax on estates valued at $4 million or more. That might spell disaster for your heirs.
