Does Illinois tax annuity income? It depends entirely on where the annuity lives. Distributions from an annuity held inside a qualified retirement plan, such as a 401(k), 403(b), traditional IRA, or government pension, are fully exempt from Illinois income tax with no dollar cap. A non-qualified annuity you bought on your own with after-tax money does not get that break, and its taxable earnings are hit with the state’s flat 4.95% income tax.1Illinois Department of Revenue. Income Tax Rates
That single distinction, qualified versus non-qualified, drives every other answer on this page.
Which Annuities Illinois Exempts
Illinois offers one of the broadest retirement income exemptions in the country. You subtract the full federally taxed amount of a qualifying distribution on Line 5 of Form IL-1040, and it drops out of your state tax base entirely.2Illinois Department of Revenue. IL-1040 Instructions – Step 3 Base Income
The subtraction is defined by statute at 35 ILCS 5/203(a)(2)(F), and it ties directly to specific Internal Revenue Code sections that govern qualified plans. Annuity distributions covered by the exemption include:3Illinois General Assembly. 35 ILCS 5/203 – Base Income Defined
- 401(k) and other qualified employer plan distributions taxed under IRC Sections 402(a) or 402(c)
- 403(a) qualified annuity plans and 403(b) tax-sheltered annuities
- Traditional IRAs, SEP-IRAs, and SIMPLE IRAs under IRC Section 408
- Federal, state, local, and military retirement systems
- Retirement payments to retired partners excluded from self-employment income under IRC Section 1402
- The federally taxed portion of Social Security and railroad retirement benefits
The list is the whole rule. If your annuity’s tax treatment doesn’t trace back to one of those IRC sections, the subtraction does not apply. Illinois Publication 120 says it plainly: you may not subtract “income that is not from a qualified employee benefit plan.”4Illinois Department of Revenue. Publication 120 – Retirement Income
A privately purchased non-qualified annuity, the kind you buy from an insurance company with money that has already been taxed, is not on that list. This is where most Illinois taxpayers get tripped up.5Illinois Department of Revenue. Does Illinois Tax My Pension, Social Security, or Retirement Income?
What Illinois Actually Taxes
Because the subtraction only reaches qualified plan distributions, every dollar of federally taxable non-qualified annuity income flows straight through to your Illinois return at 4.95%. That’s true whether you’re taking periodic payments, a partial withdrawal, or a full surrender.
A concrete example. You bought a deferred annuity years ago with $100,000 of after-tax savings, and the contract has grown to $150,000. If you surrender it, the $50,000 gain is ordinary income on your federal return and also taxable in Illinois, producing roughly $2,475 in state tax on the gain alone. If you annuitize instead, the federal exclusion ratio splits each payment between tax-free return of principal and taxable earnings, and the taxable slice still lands on your Illinois return with nothing to offset it.
Illinois uses your federal adjusted gross income as its starting point, so whatever the IRS treats as taxable is already sitting on Line 1 of your IL-1040. Without a subtraction, it stays there.
Early Withdrawals
Pulling money from a qualified annuity before age 59½ still qualifies for the Illinois subtraction, because the distribution comes from a qualified plan. What doesn’t go away is the 10% federal early withdrawal penalty on the taxable portion, which is a separate federal tax.6Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions Illinois does not tack on its own early withdrawal penalty.
For a non-qualified annuity, the federal 10% additional tax also applies to the taxable portion of a pre-59½ distribution, with limited exceptions.7Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Illinois still taxes the earnings at 4.95% on top of that.
Inherited Annuities
If you inherit an annuity, the same qualified-versus-non-qualified split governs your Illinois tax bill. Distributions from an inherited qualified annuity, such as one inside an IRA, remain eligible for the Line 5 subtraction because they still trace back to the IRC sections listed in the Illinois statute.
An inherited non-qualified annuity does not. The beneficiary owes federal tax on the earnings portion, and that same amount is taxed by Illinois at 4.95%. A surviving spouse who continues the contract as their own can defer the tax; non-spousal beneficiaries generally cannot.
If You Move Into or Out of Illinois
Part-year residents owe Illinois tax on annuity income received during the months they lived in Illinois, no matter where the annuity company is based. The retirement income subtraction still works for qualifying distributions taken during the resident stretch of the year.8Illinois Department of Revenue. IL-1040 Schedule NR Instructions
Nonresidents are off the hook. Illinois does not tax pension or annuity income of people who live in another state, even if the annuity was purchased or the employer plan was set up while you were living in Illinois. The Schedule NR instructions tell nonresidents not to enter an amount for taxable pensions and annuities at all.
One snowbird trap worth knowing: spending winters in Florida does not, by itself, make you a part-year resident. If your Illinois domicile stays intact, you’re a full-year resident and Illinois taxes everything the subtraction doesn’t cover.
Reporting Annuity Income on Form IL-1040
Your federal adjusted gross income already contains the taxable portion of any annuity distribution you reported to the IRS. What you do next depends on which kind of annuity it came from.
For a qualifying distribution from a 401(k), 403(b), IRA, or government retirement plan, enter the federally taxed amount on Line 5 of Form IL-1040. That subtracts it from your base income, and you owe no Illinois tax on it. Do not use Schedule M for this. The Schedule M instructions specifically send retirement income to Line 5 instead.9Illinois Department of Revenue. Schedule M Instructions (IL-1040)
For a non-qualified annuity, there is nothing to subtract. The taxable earnings sit inside your federal AGI on Line 1 and get taxed at 4.95% along with the rest of your income.
If your only income is Social Security and qualified retirement distributions, your Illinois base income after Line 5 may be zero. You may not need to file at all in that case, though filing is still worthwhile if Illinois tax was withheld and you want it back.