Illinois §401(k) and Retirement Income Taxation in 2026: The Full-Exclusion State, the Free Roth Conversion, and the Domicile Playbook

Illinois is the largest state in the country that fully excludes qualified retirement income from state income tax. It has been the case since 1969, when the Illinois General Assembly enacted the original Illinois Income Tax Act and codified the retirement subtraction that appears today at 35 ILCS 5/203(a)(2)(F).^[1] The subtraction has no dollar cap, no phase-out, no minimum age requirement independent of the underlying plan's own distribution rules, and no restriction to a particular class of taxpayer. It covers §401(k), §403(b), §457(b), traditional IRA, Roth IRA, SEP-IRA, SIMPLE IRA, federal and state pension, military pension, and Social Security — every category of qualified retirement account that Congress has enacted since ERISA in 1974.^[2] Combined with the flat 4.95 percent rate under 35 ILCS 5/201(b)(5.4), an Illinois resident drawing a $200,000 annual retirement income from a mix of 401(k), Social Security, and pension pays $0 in Illinois state income tax. A California resident at the same income level pays roughly $12,000. A New Jersey resident above the pension exclusion cliff pays roughly $17,000. An Illinois resident, zero.

The consequences ripple far beyond the retirement-drawdown phase. Because Illinois exempts qualified plan distributions at 0 percent regardless of age, an Illinois resident executing a $300,000 Roth conversion at age 62 pays zero Illinois tax on the conversion — the single largest state-tax arbitrage opportunity available anywhere in the U.S. tax code for a household with substantial pretax retirement assets. Because Illinois taxes wages and self-employment income at 4.95 percent flat but exempts qualified retirement distributions at 0 percent, the Traditional-vs-Roth 401(k) decision for a working Illinois resident is one of the cleanest federal-only marginal-rate arbitrages available in any state. And because SECURE 2.0 §603 mandatory Roth catch-up produces identical state-tax outcomes on both the contribution and distribution side, an Illinois resident approaches the §603 decision as a purely federal question — the Illinois axis drops out entirely.^[3]

This is the 2026 field guide for the Illinois retirement income tax perimeter. It covers what qualifies for the §203(a)(2)(F) subtraction, what does not, the flat 4.95 percent rate, the Illinois estate tax offset, the Roth conversion arbitrage math, the SECURE 2.0 §603 neutrality, three worked case studies at $180,000 / $340,000 / $580,000 income levels, cross-border relocation planning both directions, the Illinois-nonqualified-deferred-compensation edge cases, and the pre-retirement-move planning window. If you are a working Illinois resident or a late-career high-income household considering an Illinois domicile change, the numbers below are the ones that determine how much of your accumulated retirement wealth Illinois lets you keep. When you want to model any of it against your own numbers, the Illinois income tax calculator, the 401(k) calculator, and the Roth IRA conversion calculator handle the arithmetic.

What Illinois §203(a)(2)(F) actually exempts (and the constitutional history)

The Illinois Income Tax Act of 1969 was Illinois's first personal income tax. It was enacted only after Illinois adopted the Revenue Article of its new 1970 Constitution, which at Article IX §3(a) requires that any income tax be a single non-graduated rate imposed on individuals — the constitutional prohibition on graduated brackets that is unique to Illinois and Michigan among the fifty states.^[1] Under this constitutional constraint the General Assembly cannot introduce graduated income tax rates without a constitutional amendment; the November 2020 "Fair Tax" amendment that would have removed the flat-rate requirement failed at the ballot box with 55 percent voting no. The flat rate is now 4.95 percent for individuals under 35 ILCS 5/201(b)(5.4), effective for tax years beginning on or after July 1, 2017.^[4]

From the beginning the Illinois income tax carried a subtraction modification for retirement income. The current text at 35 ILCS 5/203(a)(2)(F) reads (paraphrased): "An amount equal to the aggregate amount received by the taxpayer during the taxable year as retirement payments made pursuant to a public retirement plan (federal, state, or local), a plan qualified under §401(a), a plan under §403(a), a plan under §403(b), a plan under §408 (individual retirement accounts and annuities including Roth IRAs), a plan under §408(k) (simplified employee pensions), a plan under §408(p) (SIMPLE IRAs), a plan under §457 (eligible deferred compensation plans of state or local government and certain tax-exempt organizations), an amount received from a self-employed retirement plan qualified under §401(c)(1), and pension income received on account of any government service." Social Security is separately excluded under §203(a)(2)(B).^[5] Illinois Department of Revenue Publication 120 walks through the eligible plan types in operational detail and provides the reporting mechanics on Schedule M of the Illinois Individual Income Tax Return (Form IL-1040).^[6]

The exclusion has no dollar cap. This distinguishes Illinois from other partial-exclusion states such as Georgia (up to $65,000 per person for age 65+), New York (up to $20,000), New Jersey (up to $100,000 MFJ, cliff phaseout above $150,000 gross), or Pennsylvania (retirement-age distribution exempt but requires meeting age plus separation-from-service tests). It has no age gate independent of the underlying plan's own §72 or §401(a)(9) rules. It has no phase-out at higher income levels. And it applies to Roth qualified distributions the same way it applies to traditional pretax distributions — both are subtractions from federal AGI on Line 5 of Schedule M feeding through to IL-1040 Line 5. The Roth versus Traditional 401(k) decision at the state level is completely symmetric in Illinois.

The four-state framework: PA, CA, NJ, IL side by side

This guide is the fourth in a series that maps the state-tax treatment of §401(k) plans against four archetypal state models. The earlier three pieces covered Pennsylvania (contribution-point taxation with retirement-age exemption), California (federal-conforming with substantial rate cost), and New Jersey (split-mirror across plan types). Illinois completes the framework as the "Category B full-exemption" pole. The table below shows how the four states treat the four key events in a §401(k) participant's life cycle.^[7]

See our Pennsylvania §401(k) after-tax basis guide, California §401(k) and IRA basis guide, and New Jersey §401(k), §403(b), and §457 basis guide for the parallel deep-dives.

The pattern that emerges is striking. Illinois and Pennsylvania both exempt retirement-age distributions, but they arrive at that result through different mechanics: Illinois via a bright-line subtraction with no age or basis test, Pennsylvania via a contribution-point taxation offset by a retirement-age exclusion. California and New Jersey both tax retirement distributions at meaningful rates, but California conforms to federal §401(k) treatment while New Jersey uniquely does not for certain plan types. On the Roth conversion axis, Illinois delivers a $0 result. On the SECURE 2.0 §603 axis, Illinois delivers a $0 result at the state level. On both axes, an Illinois resident makes a purely federal decision.

The Illinois flat 4.95 percent rate and how retirement income drops out

Illinois uses federal AGI as its starting point for individual income tax under 35 ILCS 5/203(a). From federal AGI the Illinois individual makes additions and subtractions to arrive at Illinois net income under §203(e), then computes Illinois tax under §201 at the flat 4.95 percent rate on the base above the Illinois personal exemption. For 2026 the personal exemption is $2,850 per person under 35 ILCS 5/204(a)(1), and Illinois provides an additional $2,850 exemption for taxpayers age 65 or older under §204(a)(2)(B).^[8]

The subtraction modification for retirement income under §203(a)(2)(F) removes qualified retirement distributions from the Illinois tax base entirely. The subtraction is reported on Schedule M, Line 5 (Retirement income eligible for the retirement income subtraction). The taxpayer enters the total of pension, 401(k), 403(b), 457, IRA, Roth IRA, SEP, SIMPLE, and government retirement plan distributions received during the tax year. Social Security is reported on Schedule M Line 1 (Social Security and railroad retirement benefits included in your federal AGI). The two together produce a single dollar-for-dollar reduction against federal AGI. On IL-1040 Line 5, the total subtractions flow through and reduce Illinois base income before applying the flat rate.

Because both terms in the parenthetical are unlimited and the retirement income exemption tracks the entire qualified plan universe, a household drawing entirely from qualified retirement plan sources plus Social Security produces an Illinois tax of $0 at any income level. A hypothetical household drawing $500,000 per year from a mix of pension, 401(k), and Social Security still owes zero Illinois state income tax. The only Illinois income that would be state-taxable is any non-qualified investment income (bond interest, non-qualified dividends, capital gains from taxable brokerage accounts, rental income, business income), which then pays the 4.95 percent flat rate on the amount over the personal exemption.

Which plan types qualify for the §203(a)(2)(F) subtraction (and which do not)

The subtraction perimeter tracks the federal statutory categories of qualified and near-qualified retirement plans. The following are inside the perimeter and fully excluded from Illinois tax on distribution:

• IRC §401(a) qualified plans — defined benefit pensions, §401(k) profit-sharing plans, ESOPs, money purchase plans, target benefit plans, cash balance plans
• IRC §403(a) qualified annuities — pre-ERISA and small-employer variants
• IRC §403(b) tax-sheltered annuities — public education employees, §501(c)(3) organization employees, church employees
• IRC §408 individual retirement accounts — Traditional IRA, rollover IRA
• IRC §408A Roth IRAs — qualified and non-qualified Roth distributions equally exempt
• IRC §408(k) SEP-IRAs — including SARSEP for grandfathered plans
• IRC §408(p) SIMPLE-IRAs — both employee elective deferrals and employer contribution portions
• IRC §457(b) eligible deferred compensation plans — state and local government §457(b) and tax-exempt §457(b) top-hat
• IRC §401(c)(1) self-employed retirement plans — Keogh plans and Solo 401(k)s treated as §401(a) plans for this purpose
• Federal Employee Retirement System (FERS) and Civil Service Retirement System (CSRS) pensions
• Military pensions under 5 U.S.C. §5305 uniformed services
• State and local government pensions including all Illinois public pension systems (TRS, SURS, IMRF, JRS, GARS, SERS, CTA, Chicago police and fire) protected by Illinois Constitution Article XIII §5
• Social Security under the separate §203(a)(2)(B) subtraction

The following are OUTSIDE the subtraction perimeter and remain Illinois-taxable at 4.95 percent:

• Nonqualified deferred compensation under §409A that is not paid within the §457(b) framework — private-employer top-hat DCPs, executive supplemental retirement plans that fall outside §457(b)
• §457(f) SERPs of tax-exempt employers — because §457(f) is technically an ineligible §457 plan, not an §457(b) eligible plan; the SROF-vesting income inclusion is Illinois-taxable at 4.95 percent when included in federal AGI
• Employer stock options exercised in retirement — ISO or NSO exercise, regardless of the participant's age at exercise, is Illinois-taxable ordinary income under §421 or §83 as applicable
• Restricted stock units vesting after retirement — RSU vesting is not "retirement income" and does not qualify for the §203(a)(2)(F) subtraction
• Investment income from taxable brokerage accounts — dividends, interest, and capital gains from non-qualified accounts are Illinois-taxable
• Non-qualified annuity distributions from a §72 non-qualified annuity where the annuity is not held inside an IRA or qualified plan
• Certain deferred compensation arrangements under state or local government §457(b) that are paid to a beneficiary before the participant's separation from service age — narrow edge case

The distinction matters because a large executive compensation package can straddle both categories: qualified §401(k) and §457(b) distributions on the exempt side, and §457(f) SERP and §409A deferred comp on the taxable side. A §501(c)(3) executive with a $2 million §457(f) SERP vesting in an Illinois-resident year owes $99,000 of Illinois tax on the SROF-vesting income inclusion under §457(f)(1)(A). If the same executive were to relocate to a no-tax state or a full-exclusion state before the SROF vesting event, the Illinois exposure disappears. See our §457(f) SERP versus §457(b) top-hat comparison for the full plan-level mechanic.

The Roth conversion arbitrage: why Illinois is America's best conversion state

A Roth conversion under IRC §408A(d)(3) is a taxable distribution from a traditional IRA, §401(k), §403(b), or §457(b) that is then contributed to a §408A Roth IRA or Roth-source subaccount. Federally, the conversion amount is included in gross income and taxed at ordinary marginal rates. For state income tax purposes, the conversion amount is a distribution from an account inside the state's retirement income perimeter.^[9]

Illinois's §203(a)(2)(F) subtraction operates against the converted amount because the conversion is a distribution from a qualifying plan type. Every dollar of the conversion is subtracted before applying the 4.95 percent flat rate. Net Illinois tax on the conversion: $0. This is not an anomaly or a workaround — it is the plain reading of the Illinois statute applied to the mechanics of a Roth conversion. The Illinois Department of Revenue has not published guidance to the contrary in the 55 years since the retirement subtraction was enacted, and Illinois practitioners routinely rely on the position.

The comparison across states drives the arbitrage. On a $300,000 traditional-to-Roth conversion in 2026:

Top-marginal rates applied to full $300K conversion. Actual state tax cost depends on other income and phaseouts; this table shows the isolated conversion impact assuming the taxpayer is already in the top bracket.

Illinois residents thinking about Roth conversions should also model the interaction with the Illinois estate tax discussed below. The Roth conversion reduces the traditional pretax bucket dollar for dollar but does not reduce the total gross estate — the federal tax paid on the conversion is money that leaves the estate, so the net effect on the Illinois estate tax is a positive one: total value in the estate is reduced by the federal tax paid. This is the classic Roth conversion benefit that applies in every state, but in Illinois the state does not skim any of the conversion income on the way through.

SECURE 2.0 §603 mandatory Roth catch-up: state-tax neutrality in Illinois

SECURE 2.0 §603 amended IRC §414(v)(7) to require that catch-up contributions for participants with prior-year FICA wages above $150,000 (indexed) be made on a Roth basis starting January 1, 2026. The federal effect is that older, higher-earning participants lose the option of a pretax catch-up deferral; the $8,000 (2026 age-50 catch-up) or $11,250 (SECURE 2.0 §109 age-60-63 super catch-up) can only go to a Roth source.^[10]

For most state residents, §603 has a real state-tax cost: the pretax catch-up would have deferred both federal and state tax on the deferred amount, while the Roth catch-up is fully currently-taxed at both federal and state rates. A New York City participant deferring an $8,000 age-50 catch-up loses roughly $1,050 in state and city tax deferral in the current year that would have compounded tax-free over the accumulation period. A California participant loses roughly $760 at the 9.3 percent bracket, or up to $1,064 at the 13.3 percent top rate. A New Jersey participant loses up to $860.

For an Illinois resident, §603 has zero state-tax cost. Here is why:

• On the pretax side: The pretax catch-up (had it been allowed) would have been excluded from Illinois state income tax via the federal-AGI-conformity mechanic — Illinois starts with federal AGI, and federal AGI excludes the pretax deferral. Illinois state tax deferral: $0.
• On the Roth side: The Roth catch-up is included in federal AGI and therefore Illinois-taxable in the contribution year at 4.95 percent. The subsequent qualified Roth distribution is fully exempt under §203(a)(2)(F). Net Illinois cost: $0.

Wait — didn't the Illinois resident pay 4.95 percent on the Roth catch-up in the contribution year? Yes, but the pretax alternative would have been Illinois-taxable at the same 4.95 percent when it was distributed decades later — except that Illinois excludes the qualified distribution too. So on the pretax alternative, Illinois collects $0. On the Roth alternative, Illinois collects 4.95 percent × $8,000 = $396 in the contribution year, then $0 at distribution. The Illinois state does actually get more revenue under the Roth catch-up regime than under the pretax catch-up regime, but only because Illinois already exempted the distribution — the Roth accelerates when the Illinois-taxable event occurs while leaving the total lifetime Illinois tax at $396 in either case.

Wait again — on the pretax alternative Illinois's total lifetime tax would have been zero, because the pretax catch-up flows through federal AGI (excluded) and the distribution is state-excluded. So Illinois actually gets $396 more under Roth than under pretax. Is that a state-tax cost of §603 in Illinois after all?

Yes, but the amount is trivial — under $400 per year of forced Roth catch-up per participant, on a $500,000+ typical high-earner household with a substantial retirement-account balance. The $396 is dwarfed by the federal decision framework, which is what an Illinois resident should focus on when running the §603 calculus. See our Roth versus Traditional catch-up decision framework for the federal side.

The Illinois estate tax: the offset to the retirement income exclusion

Illinois is one of twelve states plus DC that still impose a state-level estate tax. Under the Illinois Estate and Generation-Skipping Transfer Tax Act, 35 ILCS 405, Illinois imposes estate tax on gross estates above $4 million with rates that reach approximately 16 percent at the top of the graduated schedule.^[11] The $4 million exemption is not indexed for inflation, unlike the $15 million federal exemption established by OBBBA (Pub. L. 119-21) that is indexed and much higher.^[12]

The interaction with the retirement income exclusion is critical for high-net-worth Illinois retirees. During life, the retirement income exclusion means a $10 million 401(k) balance draws down at 0 percent Illinois tax on distributions. At death, the same $10 million 401(k) balance is fully includible in the Illinois taxable estate under 35 ILCS 405/3 and, for a single decedent with no other assets, generates Illinois estate tax on the excess over $4 million at up to 16 percent — approximately $960,000 in Illinois estate tax on a $10 million qualified retirement account.

The planning implications are consequential:

• Illinois residents with retirement account balances above $4 million should model Illinois estate tax exposure and consider systematic drawdown, Roth conversions (which reduce the pretax portion but not the total gross estate), lifetime gifting to spouses (unlimited, no gift tax), lifetime gifting to non-spouses (subject to federal gift tax gift-splitting and lifetime exemption use), or life insurance held in an irrevocable life insurance trust (excluded from the taxable estate).
• Roth conversions reduce total estate value dollar for dollar by the amount of federal tax paid on the conversion. A $300,000 conversion at a 32 percent federal marginal rate reduces the estate by $96,000 of federal tax that leaves the estate to pay the conversion tax. On the reduced remaining estate, the Illinois estate tax exposure drops proportionately. This is a valuable interaction that Illinois residents should model when planning conversions.
• Portability of the deceased spousal unused exemption (DSUE) is a federal-only concept. Illinois does not permit DSUE portability — the surviving spouse's Illinois exemption is fixed at $4 million regardless of how much of the deceased spouse's $4 million was used. A married couple can protect up to $8 million from Illinois estate tax through a bypass-trust structure at the first spouse's death; without a bypass trust the second spouse's estate faces Illinois tax above $4 million even if the first spouse died with $0.
• The Illinois estate tax is an offset to the retirement income exclusion, not a nullification of it. Even at maximum exposure, the Illinois estate tax on a $10 million retirement account balance ($960,000) is far less than the state income tax that would have been paid on the same $10 million drawn down over 20 retirement years in a comparable-rate state (New Jersey at 10.75 percent on $10 million over the retirement span, plus estate exposure, produces net far higher combined state tax).

Three worked case studies

Case 1: Priya, 45, Chicago software engineer at $180,000, evaluating Traditional vs Roth 401(k)

Priya is a senior software engineer at a Chicago-based fintech company. Her 2026 gross compensation is $180,000. She defers the full $23,500 §401(k) elective deferral limit and is deciding between Traditional and Roth 401(k) treatment. Her employer offers both options. She has no state-specific reason to prefer one over the other — the Illinois retirement income exclusion means both options produce identical Illinois results at both contribution and distribution.

Priya's 2026 tax picture running Traditional (pretax) deferral:

• Federal AGI: $180,000 − $23,500 = $156,500
• Federal tax (2026 TY2025 brackets, single, standard deduction $15,000): ordinary income tax on $141,500 ≈ $27,568
• Illinois AGI: $156,500 (starts with federal AGI)
• Illinois taxable income: $156,500 − $2,850 personal exemption = $153,650
• Illinois tax: $153,650 × 4.95% = $7,606
• Total federal + Illinois: $35,174

Priya's 2026 tax picture running Roth deferral:

• Federal AGI: $180,000 (Roth deferral is included in AGI)
• Federal tax: on $165,000 taxable ≈ $32,738
• Illinois AGI: $180,000
• Illinois taxable: $180,000 − $2,850 = $177,150
• Illinois tax: $177,150 × 4.95% = $8,769
• Total federal + Illinois: $41,507

The delta between Traditional and Roth is $6,333 more current-year tax if Priya elects Roth ($5,170 federal + $1,163 Illinois). The full delta will be recouped in retirement if Priya's marginal rate at distribution is at or above her current 24 percent federal marginal (Illinois is state-tax-neutral at both ends because both contribution and distribution are Illinois-exempt via the mechanics above). If Priya's expected retirement marginal rate is below 24 percent federal, Traditional wins on lifetime tax. If at or above 24 percent, Roth wins. Priya's Illinois residence does not affect this decision — she should run the pure federal marginal-rate arbitrage. Use the 401(k) calculator to model any deferral level and both options.

Case 2: Marcus, 58, Naperville dentist at $340,000 MFJ, planning $300K Roth conversion

Marcus and his spouse file MFJ. Marcus is a partner dentist and his spouse is a Rockford-area school administrator. Their combined 2026 AGI is $340,000. Marcus is contemplating a $300,000 Roth conversion from a traditional IRA rollover balance of $1.4 million. He has held Illinois residency for 22 years and has no near-term plans to relocate. His Illinois-domiciled position is settled.

Marcus's conversion math for the current year:

• Baseline federal AGI: $340,000
• Post-conversion federal AGI: $640,000
• Federal tax on baseline (MFJ, standard deduction $30,000): $71,140 (on $310,000 taxable)
• Federal tax on post-conversion: $171,116 (on $610,000 taxable)
• Marginal federal tax on the $300,000 conversion: $99,976 (average marginal rate 33.3%)
• Baseline Illinois tax: $340,000 × 4.95% = $16,830 (subject to the $5,700 MFJ exemption reducing base to $334,300, tax = $16,548)
• Post-conversion Illinois tax: $340,000 × 4.95% = $16,548 (the $300,000 conversion is FULLY subtracted under §203(a)(2)(F))
• Marginal Illinois tax on the conversion: $0

Compared to a New Jersey resident executing the same $300,000 conversion, Marcus saves approximately $22,300 in state tax by virtue of his Illinois residency (NJ at 8.97 percent on the conversion income tranche = $26,910, minus a partial pension exclusion offset in the year of conversion, roughly net $22,300 higher NJ liability). Compared to a California resident, Marcus saves approximately $27,900 (CA at 9.3 percent on the tranche minus any partial deductions = roughly $27,900).

Marcus's total conversion cost (federal only): $99,976. His post-conversion Roth IRA balance: $300,000, growing tax-free thereafter, with all future qualified distributions state-tax-free under §203(a)(2)(F) and federal-tax-free under §408A(d)(2). If Marcus is contemplating a further conversion in subsequent years, he can execute a partial-conversion schedule spread over 3-5 years to keep his federal marginal rate below the 32 percent bracket and pay less in cumulative federal tax on the conversion income.

Case 3: Diana, 62, MFJ, planning relocation from California to Illinois before $500K Roth conversion

Diana and her spouse are California residents. Diana recently retired from a California-based executive role at $580,000. Their combined 2026 pre-relocation household AGI is approximately $420,000 (pension income, RMDs from Diana's spouse's IRA, and investment income). Diana holds a traditional IRA balance of approximately $2.2 million and is planning a $500,000 Roth conversion.

Diana's California-resident conversion math:

• California AGI (pre-conversion): $420,000
• California AGI (post-conversion): $920,000
• California tax on $500,000 conversion tranche (top marginal 12.3% at that income level plus $1,000 estimated 1% MHT/BHST if $1M threshold crossed): approximately $61,500

Diana's post-relocation Illinois-resident conversion math:

• Illinois AGI (pre-conversion): $420,000
• Illinois AGI (post-conversion): $920,000 — but §203(a)(2)(F) subtracts the entire $500,000 conversion, so Illinois taxable base for the conversion tranche: $0
• Illinois tax on the conversion tranche: $0
• California tax on the conversion tranche after Diana establishes Illinois residency: $0 (4 U.S.C. §114 blocks California from taxing former-resident retirement plan distributions)

Diana's state tax savings from the relocation: $61,500 on the $500,000 conversion. Combined with expected future state tax savings on the $2.2M IRA balance drawn down over Diana's retirement (approximately 25 years at $88K per year, versus California tax at up to 9.3 percent = $8,184 per year × 25 = $204,600 nominal lifetime tax avoided), the total state tax savings from the relocation are approximately $266,000 over the balance of Diana's retirement.

The residency-change checklist for Diana includes: (1) sell the California primary residence or convert to a rental with a bona fide arm's-length lease to a nonresident; (2) purchase or lease the Illinois residence in Diana's name and physically relocate; (3) change driver license, voter registration, and vehicle registration to Illinois; (4) establish Illinois medical providers and dental providers; (5) move brokerage accounts to an Illinois address; (6) close California bank accounts and open Illinois bank accounts; (7) wait at least 60-90 days after the physical move before executing the conversion; (8) document the timeline with a bright-line file (dated moving-truck receipt, dated utility statements, dated medical appointments) that establishes the Illinois residency date; (9) file a California FTB Form 540NR for the California-source income earned during the year of relocation and file Illinois IL-1040 as a part-year resident; (10) file California nonresident Form 540NR in subsequent years only if Diana has California-source income (which as a retiree drawing only from qualified plans, she will not). The California FTB's 15-factor Bragg residency analysis and FTB Publication 1031 domicile framework are load-bearing to establishing the residency change.^[13]

Cross-border relocation INTO Illinois: the domicile change planning window

The Illinois-resident Roth conversion strategy discussed above depends on establishing bona fide Illinois residency before the conversion event. The residency test is a facts-and-circumstances domicile analysis under 86 Ill. Adm. Code §100.3020, which follows the classic Restatement (Second) of Conflict of Laws domicile factors: physical presence, intent to make Illinois a permanent home, and the objective indicia of that intent.^[14]

Illinois's residency test is relatively straightforward compared to California's aggressive nonresident-recharacterization jurisprudence. Illinois has no separate "safe harbor" for former residents to establish nonresidency by working out of state (as California has for certain employment relationships). Illinois's test asks whether the taxpayer maintained a permanent home in Illinois and had the intent to maintain Illinois as their domicile during the tax year. Physical presence in Illinois of 183 days or more in a tax year triggers "statutory residency" under §100.3020(c) even for non-domiciled taxpayers, but the state does not aggressively pursue former nonresidents.

The relocation window planning steps for a California, New York, New Jersey, Massachusetts, or other high-tax state resident considering an Illinois domicile change before a large Roth conversion are:

1. Establish a physical residence in Illinois — buy, lease, or acquire the residence at least 60 days before the intended residency date
2. Sever origin-state connections — sell or rent the origin-state residence, change all address-of-record on financial and government documents
3. Establish Illinois government relationships — driver license, voter registration, vehicle registration, motor vehicle insurance
4. Establish Illinois professional relationships — primary care physician, dentist, attorney, CPA (retaining the origin-state CPA for transition year is fine)
5. Move banking and investment accounts — Illinois primary bank, Illinois brokerage address of record
6. Document the residency date — dated moving receipts, dated utility statements, dated first-appointment medical records
7. Wait 60-90 days before executing the conversion to build a defensible timeline
8. Execute the Roth conversion in the Illinois-resident tax year and file IL-1040 with Schedule M reflecting the §203(a)(2)(F) subtraction for the full conversion amount

Cross-border relocation OUT of Illinois: the Pension Source Tax Act protection

An Illinois resident who accumulated retirement wealth in Illinois and later relocates to another state carries the 4 U.S.C. §114 protection with them. The Pension Source Tax Act of 1996 was enacted precisely to prevent state-of-origin recapture of retirement plan distributions after residency change, and it applies to periodic-payment retirement distributions from qualified plans including §401(a), §403(a), §403(b), §408, §408A, §457(b), and §414(d) plans, as well as nonqualified deferred compensation paid at least annually over life or a period of at least ten years under §3121(v)(2)(C).^[15]

The practical result is that an Illinois resident who retires to Iowa (limited $6,000 retirement exclusion for age 55+), Kentucky (partial retirement exclusion), Missouri (limited pension exemption), or any partial-exclusion state is protected from Illinois recapture by federal law. The destination state's residency rules and retirement income treatment govern the state tax on distributions after the residency change. If the destination state is another full-exclusion state (Pennsylvania, Mississippi), or a no-income-tax state (Florida, Texas, Tennessee, Nevada, Wyoming, South Dakota, Washington, Alaska, New Hampshire), the outcome is 0 percent state tax on both ends of the residency change.

For lump-sum distributions the analysis is different. Section 114 protects "periodic payments" defined as paid at least annually over life or 10+ years. A lump-sum distribution from a qualified plan is NOT protected by §114 and is potentially subject to source-state tax if paid before the residency change is complete. Illinois does not tax the lump-sum distribution because the §203(a)(2)(F) subtraction covers it, but if the participant moves to a taxing state and then takes the lump sum, the destination state gets to tax it under its normal residency rules. The planning implication: for a large planned lump-sum distribution and a planned residency change, the sequencing matters. Execute the lump-sum distribution BEFORE the residency change to keep it in Illinois (where it is $0 state-taxable), then complete the residency change to the destination state. Or set up a periodic payment schedule that qualifies for §114 protection before relocating.

The nonqualified deferred compensation edge case

Not all deferred compensation qualifies for the Illinois retirement income exclusion. The §203(a)(2)(F) subtraction perimeter tracks the federal statutory categories of qualified and near-qualified retirement plans. Nonqualified deferred compensation under §409A that is not paid within the §457(b) framework — the classic private-employer top-hat DCP and executive supplemental retirement plans of for-profit employers — is NOT within the subtraction perimeter and is Illinois-taxable at 4.95 percent when included in federal AGI.^[16]

The interaction with 4 U.S.C. §114 partially cures the trap. Section 114 protects §3121(v)(2)(C) periodic-payment nonqualified deferred compensation paid at least annually over life or a 10-year-plus period from source-state recapture. So a private-employer NQDC arrangement paid as a 10-year installment stream will avoid Illinois recapture if the participant relocates from Illinois to a no-tax state before the distributions begin. But a lump-sum NQDC distribution paid to an Illinois resident is fully Illinois-taxable at 4.95 percent. This is a distinction from the §401(k) and §457(b) categories, which are Illinois-exempt regardless of distribution form.

Executives whose compensation includes both qualified §401(k) and nonqualified §409A DCP should track the distinction carefully. The §401(k) portion is Illinois-exempt at 100 percent. The §409A DCP portion is Illinois-taxable at 4.95 percent unless it qualifies for §114 protection through a §3121(v)(2)(C) periodic-payment structure. Restructuring an existing §409A DCP to fit within §3121(v)(2)(C) requires care under §409A(a)(3) impermissible acceleration rules — changing a lump-sum election to a periodic-payment schedule can trigger the 20 percent §409A additional tax if the change violates the anti-abuse rules of Treas. Reg. §1.409A-2(b). See our NQDC versus Roth catch-up field guide and the §457 NQDC for tax-exempt executives guide for the full mechanic.

The property tax offset: Senior Citizens Homestead Exemption

Illinois has the second-highest average effective property tax rate in the country (approximately 2.05 percent of home value, versus a national average of approximately 1.05 percent), a fact that partially offsets the retirement income tax exclusion for households whose retirement wealth includes substantial home equity.^[17] The Illinois legislature has provided several targeted property tax reliefs for seniors that most retiree households qualify for:

• Senior Citizens Homestead Exemption under 35 ILCS 200/15-170 — $5,000 reduction in equalized assessed value (EAV) for homeowners age 65+, up to $8,000 in Cook County. Applied automatically at the county assessor level upon application; renews annually.
• Senior Citizens Assessment Freeze Homestead Exemption under 35 ILCS 200/15-172 — freezes the EAV at the prior-year level for homeowners age 65+ with household income below $65,000 for tax year 2025. Prevents assessment increases that would otherwise raise the property tax as the underlying home value rises. This is one of the more valuable Illinois senior benefits and is worth pursuing aggressively for households near the income threshold.
• Senior Citizens Real Estate Tax Deferral Program under 320 ILCS 30/ — allows homeowners age 65+ with income below $65,000 to defer up to $7,500 per year of property tax as a lien on the home, repayable at sale or transfer
• Long-Time Occupant Homestead Exemption under 35 ILCS 200/15-177 — limits assessment increases for homeowners who have owned and occupied the home for at least 10 years and have income below $100,000 (may vary by county)

Property tax planning is a critical component of an Illinois retirement plan and is separate from — but complementary to — the income tax planning. A retiree drawing $150,000 per year from a §401(k) pays $0 in Illinois income tax but may still pay $8,000-$15,000 per year in Illinois property tax on a $600,000-$800,000 home, depending on the taxing district. The Senior Assessment Freeze can preserve substantial value against ongoing assessment growth.

Illinois tax on out-of-state work — the source rule

Illinois residents pay Illinois tax on all income regardless of where earned. Illinois-source income of a nonresident (Illinois wages, Illinois real property income, Illinois pass-through business income) is Illinois-taxable to the nonresident. The Illinois-resident credit for taxes paid to other states under 35 ILCS 5/601 prevents double taxation on cross-border wage income.^[18]

For retirement income, the analysis is simpler. Illinois residents receive all retirement income from qualified plans at 0 percent Illinois tax under §203(a)(2)(F), regardless of where the account is held, where the plan sponsor is located, or where the funds were originally earned during the participant's working years. Nonresidents of Illinois receiving retirement distributions from qualified plans are protected from Illinois tax by 4 U.S.C. §114 if the plan is a §401(a), §403(a), §403(b), §408, §408A, §457(b), or §414(d) plan and the distribution is a periodic payment. So the retirement-income treatment is symmetric: an Illinois resident drawing from a New York-based plan gets 0 percent Illinois tax; a former Illinois resident now living in Michigan drawing from an Illinois-based plan gets 0 percent Illinois tax.

Six mistakes Illinois residents make with retirement planning

1. Failing to file Schedule M to claim the §203(a)(2)(F) subtraction. The subtraction is not automatic — the taxpayer must file Illinois Schedule M and enter the retirement income amount on Line 5. If the taxpayer files IL-1040 without Schedule M, the Illinois tax will be computed on the full federal AGI, and the retirement income exclusion will be missed. Illinois has a 3-year statute of limitations for amended returns to claim missed subtractions.
2. Assuming the exclusion covers §457(f) SERP distributions. The §203(a)(2)(F) subtraction covers §457(b) eligible plans but does NOT cover §457(f) ineligible plans. Executives at §501(c)(3) or governmental employers with §457(f) SERPs owe Illinois tax at 4.95 percent on the SROF-vesting income inclusion under §457(f)(1)(A). Plan accordingly by timing distributions to coincide with a domicile change or accepting the Illinois tax.
3. Executing a large Roth conversion in a non-Illinois-resident year. If a taxpayer plans to establish Illinois residency for tax planning purposes and executes the Roth conversion in the tax year of the residency change, the FTB or other origin-state tax authority may take the position that the taxpayer remained a resident for part of the year and the conversion income should be allocated back to the origin state. Execute conversions no earlier than the day after Illinois residency is established, and ideally 60-90 days later, to build a defensible timeline.
4. Ignoring the Illinois estate tax exposure. Retirement-account balances above $4 million for a single or above $8 million MFJ (with bypass-trust planning) face Illinois estate tax at up to 16 percent above the exemption. High-net-worth Illinois retirees should model the estate tax exposure and consider systematic drawdown, Roth conversions (which reduce the estate value by the federal tax paid), gifting programs, or life insurance in an irrevocable trust to reduce the taxable estate.
5. Missing the Senior Assessment Freeze deadline. The Senior Citizens Assessment Freeze Homestead Exemption requires an annual application filed with the county assessor. Missing the deadline means the freeze is lost for that tax year and the assessed value follows the general market movement. Set a calendar reminder for the county-specific deadline (typically January or February).
6. Not planning around the §72(t) 10 percent penalty on early distributions. Illinois does not tax the early distribution but the federal §72(t) 10 percent penalty still applies for distributions before age 59½. Illinois residents planning early retirement should use the §72(t) SEPP exception, the age-55 separation-from-service exception, the SECURE 2.0 §115 emergency distribution provision, or the Rule of 55 as applicable. See our Rule of 55 guide for the mechanic.

Eight-item pre-retirement action checklist

Frequently asked questions

The full-exclusion pole in the four-state framework

Illinois completes the four-state framework for §401(k) treatment across the U.S. tax landscape. Pennsylvania taxes at contribution and exempts at retirement age (contribution-point taxation). California conforms to federal treatment and taxes fully at distribution at up to 13.3 percent (federal-conforming high-rate). New Jersey excludes §401(k) at contribution but taxes at distribution above the $100,000 MFJ pension exclusion cliff (split-mirror). Illinois excludes both at contribution and at distribution (full exclusion) — the model that most benefits a household with substantial pretax retirement assets and the model that makes Roth conversions state-tax-free at any amount.

For a working Illinois resident, the Traditional-vs-Roth 401(k) decision reduces to pure federal marginal-rate arbitrage. For a late-career Illinois resident considering a Roth conversion, the answer is: run it. For a high-tax-state resident with substantial pretax retirement assets and the mobility to relocate, an Illinois domicile change before a large conversion produces the single largest state-tax arbitrage available anywhere in the U.S. code. And for an Illinois retiree drawing down a substantial retirement portfolio, the tax bill is $0 at the state level regardless of income level — subject only to the property tax and the Illinois estate tax that operate under separate rules.

None of this is tax evasion or aggressive planning. All of it is the plain application of the Illinois statute enacted in 1969 as the trade-off for the constitutional prohibition on graduated income tax rates. Illinois gave up the ability to tax retirement income at higher rates by giving up the ability to tax any income at graduated rates. The result is one of the most retirement-friendly tax regimes in the country, hiding in plain sight in a state that most tax planners think of as high-cost because of property taxes and the estate tax. Both offsets are real, but neither displaces the retirement income exclusion as the dominant feature of the Illinois tax profile for retirees and near-retirees.