Michigan’s New Tax Rules on Pensions
This post is the first of a series explaining the new Michigan tax laws which are about to be signed into law.
Here, we’ll discuss the changes affecting pension income.
Historically, Michigan allowed an exemption for pension income. For those with private pensions (e.g., 401k plan from GM or an Individual Retirement Account), the State allowed a $45,120 exemption in 2010 ($90,240 for joint filers) from taxable income. For public pensions (i.e., government pensions), the exemption was unlimited—there was no tax on public pension income regardless of amount.
The original plan was to subject seniors’ entire pension income to Michigan’s 4.35% income tax. This caused a bit of a stir. The pension tax, in its final form, applies different tax rules to three age ranges.
The age ranges are:
- Those born before 1946
- Those born between 1946 and 1952
- Those born after 1952
On a joint return, it is the year of birth of the older spouse that controls the tax treatment of both spouses’ pensions.
Born before 1946
Those born before 1946 will see no change in how their pension income is taxed. Social Security income is fully exempt from Michigan tax. Seems simple so far, but wait…
Born between 1946 and 1952
If a taxpayer is born between 1946 and 1952 and is under 67 years old, the exemption amounts are changed to $20,000 for a single return and $40,000 for a joint return regardless of whether the income is from a private or public pension.
If a taxpayer is born between 1946 and 1952 and is 67 years old or older, the exemption amounts remain at $20,000/$40,000 but apply to both pension and non-pension income. This provision helps seniors because they now have a large exemption that can apply to non-pension income such as wages or business profit.
Social Security income is fully exempt from Michigan tax.
The $20,000/$40,000 exemption amounts are completely phased out if Household Resources exceed $75,000 on a single return or $150,000 on a joint return.
Born after 1952
If a taxpayer is born after 1952 and is under 67 years old, the new law eliminates any exemption of private or public pension. Social Security income is still exempt from Michigan tax.
If a taxpayer is born after 1952 and is 67 years old or older, the new law allows the $20,000/$40,000 exemption for ALL types of income—public and private pensions, non-retirement income, and Social Security income.
Under this provision, Social Security income has to be sheltered by the $20,000/$40,000 exemption amounts.
Example: It is 2020, John is 67 years old and he was born in 1953. John has $15,000 in Social Security Income and $30,000 in private pension income. John is married so he is entitled to a $40,000 exemption. John must use $15,000 of his exemption to shelter his Social Security income. John has a $25,000 remaining exemption to shelter his $30,000 pension income. John will pay tax on the remaining $5,000 pension income.
If John was born in 1952, his Social Security income would be exempt from tax without having to use his $40,000 exemption. Thus, his full $40,000 exemption would fully shelter his $30,000 pension income.
The $20,000/$40,000 exemption amounts are completely phased out if Household Resources exceed $75,000 on a single return or $150,000 on a joint return.
Tax simplification!!!
There’s a lot more in this new law to cover. Stay tuned for more updates.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.
10 Responses to Michigan’s New Tax Rules on Pensions
I'm trying to understand aspects of the new law. For one thing, what about distributions from a 457 or a 401(k) plan. My husband and I are both retired state workers. He was born in 1951 and I in 1954. I'm not looking for a specific answer, necessarily – just commenting on the kind of questions raised.
I have a feeling there will be many questions over the next year. In your case, the age of the older spouse (your husband) would control the treatment of both of your pensions. The treatment of both private (401k) and public (457) pensions will now be the same.Since your husband was born in 1951, the rules for births between 1946 and 1952 will apply. Until your husband is 67 years old, the two of you will have a $40,000 exemption you can use to shelter both of your pension incomes. Once your husband reaches age 67, you and your husband will be able to use the $40,000 exemption to shelter both pension and non-pension income. Of course, there may be more guidance in the next months so this answer may have to be revisited later in the year.
On another site, I read that our Railroad Retirement pension would not be taxed under this new law. Is this correct or did I misunderstand?
Railroad retirement pension will be treated the same as Social Security income in each of the three treatments (based on year of birth) above.
What is the effective date for these changes? Will I pay tax on my 2010 pension when I file in 2011? If so, my estimated payments have been too small.
The effective date for these changes is January 1, 2012. So your withholding for distributions taken in 2012 will have to be increased to reflect the tax change. Your distributions in 2011 will be taxed under the old law.
what if you file jointly and your wife is 2yrs older,, who's age do they go with—Thanks Bill
It's the age of the older spouse that counts.
I thought I remembered hearing that police and fire government pensions had been exempted from the new Michigan taxable pension law. Is that true or was it just talk/rumor.
Police and fire government pensions will be subject to the new pension tax (assuming recipients were born after 1946). The new law doesn't differentiate between private and public pensions.