Does Michigan Tax 401k Distributions?

The taxation of 401(k) distributions in Michigan depends on a taxpayer’s age and is subject to recent legislative changes. The state is transitioning from a multi-tiered system to a more uniform exemption that is being phased in over several years. This transition means the amount of your 401(k) income subject to the state’s flat income tax can vary. The rules are applied based on your birth year and the tax year in question.

Determining Tax Treatment by Birth Year

The rules for how Michigan taxes retirement income, including distributions from a 401(k), are based on a three-tier system determined by the recipient’s birth year. A 401(k) distribution is considered a private “retirement and pension benefit,” making it eligible for these deductions. The system creates different tax outcomes depending on when a person was born.

Born Before 1946

Taxpayers born before 1946 receive the largest deduction under the original system. For these individuals, a large portion of their private retirement income is deductible. A single filer can deduct a set amount of their private pension and 401(k) income, while married couples filing jointly can deduct double that amount. Any income from Social Security and military pensions is also completely exempt from state taxation.

Born Between 1946 and 1952

Individuals born between 1946 and 1952 are eligible for a smaller deduction on their retirement income compared to the older tier before reaching age 67. Once a taxpayer in this group turns 67, different options become available that may expand their deduction. These specific dollar-amount deductions are applied against all private retirement income, including 401(k) withdrawals.

Born After 1952

Under the initial framework, taxpayers born after 1952 had nearly all retirement and pension income, including 401(k) distributions, fully subject to Michigan’s income tax until they reached age 67. At that point, a different, more limited exemption could become available. This treatment made most retirement savings fully taxable for younger retirees.

The 2023 Retirement Tax Law Changes

Michigan enacted Public Act 4 of 2023, a law designed to phase out the state’s tax on retirement income. This legislation, part of the “Lowering MI Costs Plan,” creates a new, uniform deduction that will eventually apply to all retirees. The law does not eliminate the old tier system immediately but provides a choice for taxpayers during a transitional period.

The law introduces a four-year phase-in schedule that began with the 2023 tax year. During this time, taxpayers can choose the more advantageous of two options: calculating their deduction using the old tier system or using the new, gradually increasing deduction percentage. This choice allows taxpayers who benefited from the old rules to continue using them while providing growing relief to those in other tiers.

The new deduction is being implemented through a phase-in, with eligibility for the new percentage tied to a taxpayer’s birth year.

• For the 2023 tax year, those born through 1958 could elect to take a 25% deduction.
• For 2024, eligibility for the 50% deduction was extended to those born through 1962.
• For the 2025 tax year, taxpayers born through 1966 are eligible to claim a 75% deduction.
• Beginning in 2026, the phase-in will be complete, and all retirees can claim a 100% deduction on their retirement income up to established limits.

This change will equalize the tax treatment for most pension and 401(k) income across all age groups.

Claiming the Retirement Income Deduction

To claim the retirement income deduction on a Michigan tax return, you must report your income and calculate the allowable subtraction. The process begins with your total 401(k) distribution, which is initially included in your adjusted gross income on the main state tax form, the MI-1040. From there, the deductible portion of your retirement income is calculated and entered on a separate schedule.

The primary form for this process is Schedule 1, titled “Additions and Subtractions.” This schedule is used to adjust your federal adjusted gross income to arrive at your Michigan taxable income. You will enter the calculated deductible amount of your 401(k) and other pension benefits on the designated line for subtractions.

Another relevant form is Schedule W, the “Withholding Tax Schedule.” If you had Michigan tax withheld from your 401(k) distribution, that amount is reported here and on your MI-1040. While most tax preparation software will automatically handle the calculations, understanding the function of the MI-1040 and Schedule 1 is useful. This allows you to verify that the correct deduction has been taken, ensuring you receive the most favorable tax treatment.