Retirement and Pension Benefits
Retirement Tax Changes
What are Retirement and Pension Benefits?
Retirement and pension benefits include most income that is reported on Form 1099-R for federal tax purposes. This includes defined benefit pensions, IRA distributions, and most payments from defined contribution plans. Generally, deferred compensation income is not included in the definition of retirement and pension benefits and therefore, does not qualify for special tax treatment. Treasury uses the terms “retirement” and “pension” interchangeably unless addressing a specific situation applicable only to one type of income.
Taxable or Nontaxable?
Adjusted Gross Income (AGI) is defined as gross income in a given year minus allowable adjustments. Gross income includes (but is not limited to) your wages, dividends, capital gains, business income, and retirement distributions. AGI is calculated on your federal income tax return and is the starting point for your Michigan individual income tax return. From there, taxable and nontaxable items are added and/or subtracted from AGI to determine your Michigan taxable income.
MCL 206.30(9),(10),(11) provides guidance on the retirement benefit subtraction. To determine your allowable retirement or pension subtraction, we must consider (1) if your retirement income is considered a qualified distribution and (2) what your tax treatment options are for a given tax year.
Lowering MI Costs Plan
The Lowering MI Costs Plan (Public Act 4 of 2023), signed into Michigan law on March 7, 2023, amended (in part) MCL 206.30 to provide taxpayers with more options to choose the best taxing situation for their retirement benefits beginning tax year 2023. Although subject to a temporary 4-year phase-in period beginning tax year 2023, this new law essentially restores the pre-2012 retirement and pension subtraction for most taxpayers in Michigan beginning in 2026. This law change will ultimately benefit most retirees in Michigan while ensuring that taxpayers in unique circumstances are not harmed.
NOTE: For tax year 2022 (January 1, 2022 – December 31, 2022; due April 18, 2023), retirees must calculate their allowable retirement subtraction using the Tier structure method.
The law change took effect on February 13, 2024. Treasury is committed to ensuring that all eligible retirees can take full advantage of the expanded subtraction options. Therefore, Michigan’s 2023 tax return, forms, and instructions (e-file and paper format) incorporate all retirement and pension benefit subtraction options - including those created in the new law.
Tax Treatment
Step 1: Verify Qualified Distribution Requirements
The primary requirement for a retirement distribution, to qualify for the Michigan subtraction, is that the taxpayer must retire under the provisions of a retirement plan. Employer plans and individual plans each have specific rules for receiving pension distributions which also must be adhered to for a retirement distribution to qualify for the Michigan subtraction.
Step 2: Choose What Works Best - Option 1, Option 2, or Option 3 as Applicable
Option 1: Tier Structure Subtraction
MCL 206.30(9) outlines limitations to the retirement subtraction. If the retiree receives a qualified pension distribution per step 1, the allowable pension subtraction is calculated based on date of birth of the taxpayer (for single/married filing separate returns) or the oldest spouse (for married filing a joint return). Per these requirements, retirees are divided into three tiers.
Surviving spouses should review special eligibility requirements to determine allowable subtractions.
TIER 1 – Taxpayers Born Before 1946
- Retirees may subtract all qualifying pension benefits received from federal or Michigan public sources. The subtraction of public sources of pension income derived from other states is limited to private retirement maximums. Private retirement benefits are subtractable up to certain limits, which are adjusted for inflation.
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The 2023 private retirement limits are:
- up to $61,518 if single or married filing separate, or
- up to $123,036 if married filing a joint return.
- These maximums are subject to reduction by the amounts claimed on Schedule 1 for military pay and the following retirement or pension benefits: U.S. Armed Forces, Michigan National Guard, and Railroad Retirement Act.
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The 2023 private retirement limits are:
- If public source pension benefits are greater than the maximum private retirement income amount, no additional retirement subtraction is allowed.
- This group of retirees must file Form 4884, Pension Schedule.
TIER 2 – Taxpayers Born Between January 1, 1946 and December 31, 1952
- Generally, taxpayers born between 1946 and 1952 are not eligible for a pension subtraction under this option in 2023.
- After reaching age 67 individuals are entitled to subtract the Tier 2 Michigan Standard Deduction against all income.
- Generally, for 2023 this group of retirees will see a greater benefit claiming a Tier 2 Michigan Standard Deduction on Schedule 1. However, retirees are encouraged to review Form 4884 to determine if another subtraction option is more advantageous.
- Retirees with benefits from employment with a governmental agency that was not covered by the federal Social Security Administration should review special eligibility requirements to determine allowable subtractions.
TIER 3 – Taxpayers Born After January 1, 1953
- Most taxpayers born after 1952 have no pension subtraction in 2022.
- After reaching age 67 (on or before December 31, 2022), individuals are entitled to subtract the Michigan Standard Deduction against all income. This deduction is reduced by:
- the personal exemption amount.
- taxable Social Security benefits included in AGI, claimed on the Schedule 1, and
- amounts claimed on Schedule 1 for military pay and the following retirement or pension benefits: U.S. Armed Forces, Michigan National Guard, and Railroad Retirement Act.
- To determine Tier 3 Michigan Standard Deduction on Schedule 1, complete Worksheet 2 in the MI-1040 booklet. Generally, this group of taxpayers should not file Form 4884.
- Retirees with benefits from employment with a governmental agency that was not covered by the federal Social Security Administration should review special eligibility requirements to determine allowable subtractions.
Retirees with Benefits from Employment with a Governmental Agency not Covered by the Federal Social Security Act (SSA)
- SSA exempt employment is not covered by the federal Social Security Administration. This means the worker did not pay Social Security taxes and is not eligible for Social Security benefits based on that employment.
- Almost all employment is covered by the federal SSA. The most common instances of retirement and pension benefits from employment not covered by Social Security are:
- police and firefighter retirees
- some federal retirees covered under the Civil Service Retirement System and hired prior to 1984, and
- a small number of other state and local government retirees.
- Tier 2 and Tier 3 recipients who were not covered by the federal SSA may deduct up to $15,000 per qualifying spouse and are therefore entitled to a:
- greater Michigan Standard Deduction if born between January 1, 1946 and December 31, 1952.
- greater Michigan Standard Deduction if born between January 1, 1953 and January 1, 1957 and retired as of January 1, 2013.
- greater retirement subtraction if born after January 1, 1957 and retired as of January 1, 2013.
- retirement subtraction if recipient has reached the age of 62 (born after January 1, 1957 but before January 2, 1962) but has not yet reached the age of 67.
Surviving Spouse
Special rules apply for determining the tier limitation applicable to a taxpayer whose spouse has passed away. This surviving spouse may compute a retirement subtraction based on the date of birth of the older, deceased spouse if all the following are true:
- A joint return was filed for the tax year in which the spouse died.
- A retirement subtraction was claimed for the year in which the spouse died.
- The surviving spouse has not since remarried.
A surviving spouse born after 1945 who has reached the age of 67 and has not remarried may elect to take the greater of the Michigan Standard Deduction or the allowable retirement subtraction based on the date of birth of the older, deceased spouse.
Option 2: Qualified Fire, Police, and Corrections Retiree Subtraction
A special provision was implemented for certain fire, police, and corrections retirees. Beginning tax years on or after January 1, 2023 retirees may fully deduct, to the extent a qualifying distribution is included in AGI, retirement benefits received from Michigan service as a:
- public police or fire department employee, subject to compulsory arbitration of labor disputes under 1969 PA 312, (see especially MCL 423.232(1)(d) and (2)),
- state police trooper or state police sergeant, subject to compulsory arbitration of labor disputes under 1980 PA 17, or
- corrections officer employed by a county sheriff in a county jail, work camp, or other facility maintained by a county that houses adult prisoners.
There is no limitation to the amount of a public benefits deductible for these retirees. Private benefits may be deducted up to the private pension limits (see Option 1, Tier 1 for amounts), but any public retirement deduction claimed reduces the maximum private retirement deduction. If a surviving spouse filed a joint return in the year of death with a person who was a qualified fire, police, or corrections retiree and the couple claimed a retirement subtraction that year, that surviving spouse continues to be eligible for this subtraction.
Option 3: Phase-In Subtraction
The maximum retirement subtractions under the Phase-In Method apply to both private and public benefits combined and are available to retirees based on their year of birth, beginning with 1946. The eligible birth years expand each year until 2026, when everyone born after 1945 will be eligible for a retirement subtraction of qualified distributions. The subtraction amounts are based on a phase-in of the private pension limits (see Option 1, Tier 1 for amounts), which are adjusted annually based on the United States Consumer Price Index. The following table uses the date of birth of the taxpayer (for single/married filing separate returns) or the oldest spouse (for married filing a joint return).
Tax Year | Retiree Date of Birth | Phase-In Subtraction |
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2023 | Jan 1, 1946 - Dec 31, 1958 | up to 25% |
2024 | Jan 1, 1946 - Dec 31, 1962 | up to 50% |
2025 | Jan 1, 1946 - Dec 31, 1966 | up to 75% |
2026 | N/A | up to 100% |
Surviving Spouse rules as explained under Option 1 also apply under the Phase-in option.
Putting it all Together
For tax year 2022 (January 1, 2022 – December 31, 2022; due April 18, 2023), retirees must calculate their allowable retirement subtraction using the Tier structure calculation method.
For tax year 2023 (January 1, 2023 – December 31, 2023; due April 15, 2024) and beyond, retirees have the option to choose the best taxing situation for their retirement benefit by opting into any one of the following calculation methods each year:
- Tier structure subtraction.
- Phase-In subtraction.
- Michigan employment as a Qualified Fire, Police, and Corrections Retiree subtraction.
Retirees may need to consult the advice of a qualified tax preparer to ensure they are able to deduct the maximum amount of retirement benefits.
Tools You Can Use
To determine your allowable retirement benefit subtraction amount, use the 2023 Pension Deduction Estimator.
Additional Resources
Retirement and Pension Benefit Scenarios
MI-1040, 2023 Individual Income Tax Forms and Instructions
2023 Dividends/Interest/Capital Gain Deduction Estimator
Form 4884, 2023 Michigan Pension Schedule
Form 4884, 2023 Michigan Pension Schedule Instructions
Form: 2023 Michigan Schedule 1 Additions and Subtractions
Instructions: 2023 Michigan Schedule 1 Additions and Subtractions
Form 4973, 2023 Michigan Pension Continuation Schedule