They Retired to Arizona for the 2.5% Flat Tax. Arizona Taxes Every Dollar of the $1 Million IRA They Brought With Them, and Illinois Would Have Charged Nothing
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Consider a composite couple, newly retired, who sold their house outside Chicago and bought a place in Scottsdale. The math looked easy. Illinois taxes income at a flat 4.95%, while Arizona’s flat rate is 2.5%. Moving looked like it would cut their state income tax about in half.
Then they filed their first full Arizona return. Their $50,000 IRA withdrawal produced a $1,250 state tax bill. In Illinois, the same withdrawal would have cost them $0. Across a $1 million IRA, Arizona collects $25,000 that Illinois never would have.
Illinois Exempts Every IRA Dollar From Its 4.95% Tax
Illinois has one flat rate and a very large carve-out for retirees. According to Illinois Department of Revenue Publication 120, retirees can subtract the federally taxed portion of distributions from “an Individual Retirement Account (IRA) (including amounts rolled over to a Roth IRA)” on Form IL-1040, Line 5. The same deduction covers 401(k) payouts, government and military pensions, and Social Security.
So for a retiree living on IRA withdrawals and Social Security, Illinois’ rate applies to almost none of that income.
Arizona’s 2.5% Flat Tax Applies to Every Private IRA Withdrawal
The chain starts with federal law. Under 26 U.S.C. § 408(d)(1), any amount paid out of an IRA “shall be included in gross income.” Arizona starts its return from federal income, then lists what you may subtract in A.R.S. § 43-1022.
Social Security is on that list under § 43-1022(10). Private IRAs and 401(k)s are missing. Arizona’s only pension break is a deduction capped at $2,500, and it covers only federal civil service and Arizona public retirement plans. A corporate 401(k) rolled into an IRA gets no deduction at all. Arizona then applies its flat 2.5% under A.R.S. § 43-1011(A)(9).
$25,000 in Arizona Tax Versus $0 in Illinois
Assumptions: tax year 2026, married filing jointly, a traditional IRA with no after-tax basis, no investment growth, and dividends from a taxable account large enough to use up Arizona’s standard deduction.
| Item | Illinois | Arizona |
|---|---|---|
| Annual IRA withdrawal | $50,000 | $50,000 |
| State tax per year | $0 | $1,250 |
| State tax over 20 years | $0 | $25,000 |
| Federal tax | Identical | Identical |
If Illinois had taxed those IRA dollars at 4.95%, the lifetime bill would have been $49,500. That was the tax the couple thought they were leaving behind, and Illinois never charged it. Investment growth makes Arizona’s share bigger, because Arizona taxes every distributed dollar, including the profits.
Required minimum distributions, which start at age 73 or 75 depending on birth year, mean those withdrawals eventually happen whether the couple needs the money or not.
Why Illinois Retirees Keep Moving to Arizona Anyway
IRS migration data for 2022-2023 shows 5528 returns, covering 8751 people and $624306000 in adjusted gross income, moving from Illinois to Arizona. For some of them, the move pays off.
Illinois taxes wages, interest, dividends and capital gains at its full rate. A retiree with consulting income or a large taxable brokerage account saves more of those dollars in Arizona. Property taxes, which this comparison leaves out, can also shift the result. Living costs come out about even: the federal Bureau of Economic Analysis places Arizona’s cost-of-living index at 100.677 and Illinois’ at 99.958.
Three Moves That Protect an IRA Before You Leave Illinois
- Convert to a Roth before you move. Illinois exempts Roth conversion income. If you convert $200,000 in your last year as an Illinois resident, you owe federal tax on it but no state tax. Qualified Roth withdrawals are excluded from federal gross income under 26 U.S.C. § 408A(d)(1), so Arizona never taxes them. That conversion keeps $5,000 away from Arizona, and Roth IRAs have no required distributions while you’re alive, per the IRS. Size the conversion to stay inside your federal bracket, and saves Medicare’s two-year income lookback in mind.
- Time the move. In the year you become a resident, Arizona taxes income realized while you lived there, under A.R.S. § 43-1097(B)(1). Take that year’s planned withdrawal before you establish Arizona legal residence, then file part-year returns in both states.
- Give through qualified charitable distributions (QCDs). A QCD is generally a nontaxable distribution paid straight from your IRA to a charity, and it counts toward your RMD. Because it never enters federal income, it never reaches your Arizona return. QCDs are available starting at age 70½.
Considering a Roth conversion against a cross-country move is the kind of math worth running with a CPA or fiduciary advisor before the moving truck is reserved. Those low-tax years between a last paycheck and the first RMD are often the cheapest window a retiree ever gets to move money into a Roth, a window we sized up in detail in a free guide here.
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Vilma Rios is a tax professional, tax researcher, and financial writer with more than 15 years of experience in tax and accounting. Her work spans federal tax research, financial journalism, retirement planning, investment taxation, capital gains, inherited assets, and tax education. She specializes in translating complex tax and financial topics into clear, practical information that helps individuals, families, retirees, and investors make informed decisions.
She has presented tax information through webinars, including Spanish-language tax education, and has appeared on Telemundo 47 discussing tax topics and helping viewers understand important tax-filing requirements.
Her experience also includes tax and accounting work, tax research, IRS-related matters, and public tax education. While in college, Vilma volunteered in an IRS-sponsored tax assistance program and was recognized for her community service by local and state officials.
Known as "Your Tax Geek," Vilma is passionate about making taxes easier to understand and helping people navigate an increasingly complex tax system.
