Illinois does not tax 401k withdrawals. The state lets you subtract the federally taxed portion of any distribution from a qualified retirement plan before your Illinois income tax is calculated, so the withdrawal drops out of your state tax base entirely. At the flat 4.95% rate, that subtraction is worth roughly $495 in state tax saved for every $10,000 you take out.1Illinois Department of Revenue. Does Illinois Tax My Pension, Social Security, or Retirement Income? Federal income tax still applies, and there are a few things the exemption does not reach.
How the Illinois Subtraction Works
Illinois starts its calculation with your federal adjusted gross income, which already includes your 401k distribution. The state then allows you to subtract the federally taxed portion of that distribution on your return, removing it from the income figure the 4.95% rate is applied to.1Illinois Department of Revenue. Does Illinois Tax My Pension, Social Security, or Retirement Income?
The phrase “federally taxed portion” is the key. For a traditional 401k funded entirely with pre-tax contributions, the whole distribution is federally taxable, so the whole distribution qualifies for the state subtraction. If your account included after-tax contributions, only the taxable amount shown on your Form 1099-R can be subtracted.2Illinois Department of Revenue. Publication 120, Retirement Income
There is no age requirement and no income limit. A withdrawal at 40 gets the same treatment as one at 75, and the exemption applies whether your total income is modest or well into seven figures. Early distributions from a qualified plan are covered too: if you tap the account before 59½, Illinois still exempts the federally taxed amount from state tax.2Illinois Department of Revenue. Publication 120, Retirement Income
What Else the Exemption Covers
The retirement income subtraction is not limited to 401k plans. It also reaches the federally taxed portion of:
- 403(b) plans and Section 457 governmental deferred compensation plans
- Traditional IRAs, SEP IRAs, and conversions from traditional IRAs to Roth IRAs
- Government pensions, including military and railroad retirement, and private pensions from qualified plans
- Social Security benefits
- Retirement payments to retired partners, and capital gains from net unrealized appreciation on employer securities distributed in a lump sum
What Is Not Covered
The subtraction applies only to distributions from qualified retirement plans as defined in the Internal Revenue Code. Nonqualified deferred compensation payouts do not qualify. Top-hat plans, supplemental executive retirement plans, and similar nonqualified arrangements are taxed at the full 4.95% Illinois rate.3Illinois General Assembly. 35 ILCS 5/203
Ordinary investment income stays taxable in Illinois as well. Interest, dividends, and capital gains from a regular brokerage account are part of your Illinois tax base with no comparable subtraction available.
How to Claim It on Form IL-1040
You claim the subtraction directly on the Illinois Individual Income Tax Return, Form IL-1040. Your federal adjusted gross income goes on Line 1, carrying the 401k distribution with it. The federally taxed retirement and Social Security income then goes on Line 5, which is the line labeled for this subtraction. The amount entered there is removed from your Illinois tax base before the 4.95% rate is applied.4Illinois Department of Revenue. 2025 Form IL-1040 Instructions, Illinois Individual Income Tax
The number on Line 5 should match the taxable amount from your Form 1099-R and your federal return. Illinois requires you to attach pages 1 and 2 of your federal Form 1040 or 1040-SR to support the subtraction.2Illinois Department of Revenue. Publication 120, Retirement Income
Schedule M handles other Illinois adjustments, such as subtracting U.S. government bond interest. If the retirement income subtraction is your only adjustment, Line 5 on the IL-1040 is enough on its own.
Federal Tax Still Applies
The Illinois exemption is a state benefit only. The IRS treats a traditional 401k distribution as ordinary income, and every dollar you withdraw is added to your federal adjusted gross income and taxed at your marginal rate.5Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust
When the plan pays a distribution directly to you, the administrator must withhold 20% for federal tax. That withholding is a prepayment, not an extra tax; you reconcile it against your actual liability when you file. A direct trustee-to-trustee rollover to another qualified plan or IRA avoids the withholding entirely.6Internal Revenue Service. 401k Resource Guide Plan Participants General Distribution Rules
Early Withdrawals Before 59½
Illinois exempts early distributions regardless of the reason. The federal side is different. If you take money from your 401k before age 59½, the IRS charges an additional 10% tax on the taxable portion unless an exception applies.7Internal Revenue Service. Topic No. 558, Additional Tax on Early Distributions From Retirement Plans Other Than IRAs
Common exceptions for 401k plans include:
- Separation from service in or after the year you turn 55, or age 50 for public safety employees of state or local governments
- Total and permanent disability
- Unreimbursed medical expenses exceeding 7.5% of adjusted gross income
- Qualified birth or adoption expenses, up to $5,000 per child
- Federally declared disaster losses, up to $22,000
- Distributions to a domestic abuse victim, up to the lesser of $10,000 or 50% of the account
- One emergency personal expense distribution per year, up to the lesser of $1,000 or the vested balance above $1,000
- Certified terminal illness
If the distribution code in Box 7 of your 1099-R does not reflect an exception you qualify for, you file Form 5329 with the IRS to claim it.8Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions None of these exceptions matter for Illinois purposes, because the state exempts the distribution either way.
Required Minimum Distributions
Starting at age 73, the IRS requires annual withdrawals from a traditional 401k. The amount is calculated from your account balance and life expectancy. Missing an RMD triggers a 25% penalty on the shortfall, reduced to 10% if you correct it within two years.9Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
If you are still working at 73 and do not own 5% or more of the company sponsoring your 401k, you can delay RMDs from that employer’s plan until you actually retire. The exception does not apply to IRAs or to plans from former employers. Your first RMD is due by April 1 of the year after you turn 73, and every one after that by December 31. Delaying the first distribution into the following April means two RMDs land in the same tax year, which can raise your federal bracket. On the Illinois side, both remain fully exempt.