Illinois taxes for early retirees: retirement income exempt, property tax not

By Tom, CPA · Updated October 25, 2026

TL;DR: Illinois taxes income at a flat 4.95%, but it lets you subtract federally taxed retirement income: 401(k) and IRA distributions (including early ones), Roth conversions, pensions and Social Security. That makes Illinois surprisingly good for a Roth conversion ladder. Interest, dividends, capital gains and wages are taxed, and property taxes are high.

Educational only, not tax, legal, or investment advice. Examples are illustrations, not predictions. Rules and limits change; verify current figures and talk to a qualified professional about your situation.

Illinois has a reputation for high taxes, and its property taxes earn it. But its income tax treatment of retirement money is one of the most generous in the country, and unusually friendly to early retirees.

Under Illinois Department of Revenue Publication 120, federally taxed distributions from 401(k)s, IRAs and other qualified plans can be subtracted, including early distributions and amounts converted to a Roth IRA. For a FIRE household with a big traditional balance, that's a rare combination. Here's how it works.

CPA Warning Label: Illinois may cause cognitive dissonance: a state famous for taxes that ignores your Roth conversion. Enjoy it, then open the property tax bill.

Flat rate

Illinois taxes individual income at a flat 4.95%, per the Department of Revenue, after a personal exemption allowance. There's no separate capital gains rate, so gains, dividends and interest are taxed at 4.95%.

Illinois starts with federal AGI and then applies additions and subtractions. The retirement income subtraction is the big one for retirees.

Qualified retirement income exemption

According to Publication 120, you can subtract the federally taxed portion of:

• Qualified employer plan distributions, including 401(k) plans
• IRA and SEP distributions, including amounts rolled over (converted) to a Roth IRA
• Social Security and railroad retirement benefits
• Government retirement and disability plans, including military
• State and local government 457 plan distributions
• Net unrealized appreciation on employer securities from a lump-sum distribution

Income you can't subtract includes non-qualified deferred compensation, third-party sick pay and amounts using federal 10-year averaging.

Early withdrawal treatment

Publication 120 states plainly that you may include early distributions from qualified plans and IRAs in the subtraction. There's no age test like Pennsylvania's 59 1/2 rule or Georgia's 62 and 65 gates.

For FIRE planning, that's powerful:

• A Roth conversion ladder started at 40 costs federal tax only.
• A 72(t) SEPP or rule-of-55 withdrawal is Illinois-tax-free.
• Even a penalized early withdrawal is subtractable for Illinois, though the federal 10% penalty still applies.

What remains taxable: interest, dividends, capital gains, rental income and wages. So the Illinois bill depends mostly on your taxable brokerage account and any side income.

Property taxes

Here's where Illinois makes up for its generosity. Property taxes are set locally and are among the highest in the country in many areas, especially suburban Chicago. For a homeowner with modest taxable income, the property tax bill can easily exceed the income tax bill.

Illinois offers homestead exemptions for owner-occupants, plus a senior citizens homestead exemption and a senior assessment freeze for older homeowners who meet income limits. Amounts and rules vary by county, especially in Cook County. Check with the county assessor.

Example

Illustration. Hypothetical married couple, both 48, retired in Illinois.

Illinois tax is about 4.95% of $25,000 before the exemption allowance, roughly $1,238. In a state that taxed the conversion at 4.95%, the bill would be about $4,200. Over ten years of conversions, the difference is about $30,000.

Now add property tax on a $400,000 suburban home, which could be several times the income tax bill. The net verdict depends on housing: renters or owners of modest homes do well; owners of large homes may not.

How Illinois changes the FIRE playbook

In most income tax states, early retirees try to minimize traditional account withdrawals and conversions because the state takes a cut. Illinois flips that. The cheapest income for Illinois purposes is retirement account money, and the most expensive is taxable-account income.

• Asset location: holding bonds and high-dividend funds inside IRAs, and broad low-dividend index funds in taxable accounts, reduces Illinois tax.
• Conversions first: since conversions are state-tax-free, the federal bracket math and ACA premium credits decide how much to convert.
• Gain harvesting costs something: unlike the federal 0% bracket, harvested gains are taxed at 4.95% by Illinois. Harvest when it's worth it, not by reflex.
• Moving later: people planning to leave Illinois eventually sometimes do their conversions while still residents, since a destination state might tax them.

Frugal Fran calls this "the upside-down state." Lavish Larry calls it "Chicago" and goes to get a hot dog.

Common Illinois mistakes

• Not claiming the retirement subtraction on early distributions or conversions.
• Forgetting to attach the required federal pages or 1099-Rs.
• Moving out before a conversion ladder to "save state tax" that Illinois wasn't charging.
• Underestimating property taxes when buying.

Moving to or from Illinois

Illinois taxes residents on all of their income and nonresidents generally only on income from Illinois sources. In the year you move, you'll usually file as a part-year resident and split income by date. Retirement account withdrawals and investment income generally follow your residence on the date you receive them, so the timing of a big Roth conversion or sale relative to the move can change which state taxes it.

Make the move clean: driver's license, vehicle and voter registration, mailing address, doctors and banks should all point to the same place. States you leave may look closely at where you spend your time and where your closest ties are. See changing state tax residency.

Federal taxes still apply

Whatever Illinois does, the federal system still sets the base. For 2026 the federal standard deduction is $16,100 for single filers and $32,200 for married couples filing jointly, and long-term capital gains can fall in a 0% bracket at lower incomes. Many early retirees aim to fill the low federal brackets each year with Roth conversions or gain harvesting. State tax then rides on top, so check how Illinois treats each type of income before deciding how much to convert. Social Security can become partly taxable federally as other income rises, and Medicare premiums later depend on income from two years earlier. A year of very low income can be just as wasteful as a year of very high income, because unused low brackets disappear on December 31. See 2026 tax brackets for FIRE.

Health coverage before Medicare

Before Medicare at 65, most early retirees in Illinois buy coverage through the ACA Marketplace (HealthCare.gov or the state exchange). Premium tax credits depend on household income, so the same withdrawal choices that drive Illinois income tax also drive what you pay for insurance. Price plans for your actual county, since insurer choice and premiums vary a lot between metro and rural areas. If your taxable income will be very low, check Medicaid eligibility rules for Illinois too. Our guides to the ACA subsidy cliff and managing MAGI go deeper.

One practical tip: estimate next year's income before open enrollment, then pick withdrawals to land where you planned. Surprises in either direction get reconciled on your federal return, and from 2026 there is no cap on repaying excess advance credits.

Your Illinois planning checklist

Use this as a starting list when you are weighing a move or planning withdrawals. Work through it a year before you leave your job, and again each fall before you decide on Roth conversions.

• Claim the retirement income subtraction on Form IL-1040 for all federally taxed retirement distributions and conversions.
• Attach federal pages and 1099-Rs as Publication 120 requires.
• Hold tax-efficient funds in taxable accounts, since dividends and gains are taxed.
• Check senior homestead and assessment freeze programs at the eligible age.

Tax rules change every legislative session. Confirm current figures with the Illinois revenue department before acting, and treat this page as education, not advice for your situation.