Leaving Illinois for Estate Tax Reasons: Don’t Overlook the Retirement Income Tradeoff

The Core Planning Question

For many high-net-worth Illinois residents, the idea of moving to a no-estate-tax state can look compelling. Illinois has a separate estate tax with a $4 million exemption, meaning estates above that level can face a state-level transfer tax even when no federal estate tax is due. Illinois also provides one of the most favorable state income tax regimes for retirees because qualifying retirement income – pension, IRA, 401(k), 403(b), 457, and Social Security distributions – can generally be subtracted from Illinois income.

The result is a planning dilemma: moving may reduce or eliminate future Illinois estate tax exposure, but remaining in Illinois may preserve annual state income tax savings on retirement distributions. The answer that optimizes overall income tax and estate tax savings depends on estate size, retirement income level, asset composition, expected longevity, spending needs, charitable intent, and the tax profile of the destination state.

Why Illinois Estate Tax Drives Relocation Conversations

Illinois’s estate tax exemption is much lower than the federal exemption and is not portable between spouses in the same way the federal exemption can be. Further, the Illinois exemption is not indexed to increase each year with inflation.

For unmarried individuals, widows, widowers, and married couples without an Illinois optimized estate plan, this can create meaningful tax exposure. Illinois real estate, retirement accounts, taxable investments, business interests, and life insurance may all contribute to the taxable estate.

The Tradeoff: Illinois Does Not Tax Most Retirement Income

Illinois imposes a flat income tax on most taxable income, but qualifying retirement income is generally subtracted from Illinois income. For retirees with large annual distributions from traditional IRAs, 401(k)s, pensions, or other qualified plans, this exemption can be valuable. For example, a retiree taking $300,000 of IRA distributions in Illinois pays no state tax for that income. Just over the border in Wisconsin, those distributions are generally taxable as ordinary income and would result in a state tax bill approaching $23,000 for some taxpayers, although the actual amount depends on filing status, deductions, and Wisconsin’s graduated tax rates. However, Wisconsin does not levy a transfer tax on estate assets.

Currently, just 12 states impose an estate tax, leaving 38 alternative tax homes for consideration. Further, 8 states are fully income tax free and do not levy an estate tax.

Planning Factors Beyond the Headline Tax Rates

• Estate size and growth rate: A $5 million estate and a $15 million estate may call for very different planning conclusions.

• Retirement income mix: Illinois’s benefit is greatest when annual cash flow comes heavily from qualified retirement plans rather than taxable investment income.

• Destination-state rules: Some states have no income tax, some tax retirement income, and some offer partial exemptions or age-based exclusions.

• Property, sales, and local taxes: A move that saves estate tax may increase other recurring taxes or cost of living.

• Domicile requirements: A taxpayer must genuinely change domicile, not simply spend time elsewhere, to avoid Illinois residency and estate tax issues.

• Non-tax considerations: Family, health care, lifestyle, weather, charitable commitments, and business ties often matter as much as tax savings.

A Practical Framework

Before moving primarily for tax reasons, high-net-worth Illinois residents should carefully model potential outcomes and understand decision points. When considering overall tax burden, it is important to project future income tax and estate tax expectations. Starting with asset composition and value today, modeling should then apply variables for multiple longevity time frames, income tax drag, spending levels, gift and charitable planning consideration, and investment returns.

The key takeaway is that Illinois is not simply a “good tax state” or a “bad tax state” for retirees – it depends. The relocation analysis must weigh both the one-time transfer tax risk and the recurring annual income tax benefit.

Threading the Needle

Many residents plan to eventually move from Illinois for both tax and non-tax reasons – whatever the motivation, there is an optimal path.

Through the lens of tax planning, many high-net-worth residents can have it both ways by accelerating retiree income while a resident of Illinois and leaving the state before their final day. For those with pre-tax IRA and 401(k) balances, retiree income can be accelerated through strategic Roth conversions over time. As pre-tax balances are converted to tax-free Roth balances, the Illinois income tax benefit is forever captured. With each conversion, the forward tax benefit of remaining in Illinois diminishes, and the case for relocating away from the Illinois estate tax burden becomes more compelling. Federal tax liability and other factors must also be considered for any Roth conversion strategy.

Longevity being the great unknown of any planning scenario, the reward for optimizing Illinois tax residency carries the risk of staying too long. It is critical to understand the multitude of variables and potential outcomes when considering your “next move.”

Your JMG advisor can help you evaluate the relevant planning and tax implications when considering a move to another state. We invite you to share this article with others who may also find it useful.

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