If you live in Michigan and you're drawing income from a pension or IRA, there’s a chance you’ve been over withholding on state taxes for the last few years…
Back in the summer on an episode of Market Pulse, we talked about one of the biggest financial shifts to hit Michigan retirees in over a decade. It wasn’t a federal law or a new IRS rule, but a quiet change right here in our home state.
Even though this law has been in the books for a while, it’s certainly flown under the radar, and most retirees are unaware of the benefit coming their way. So, we decided to do a deeper dive here on the blog to explain exactly what is happening in 2026, why so many people are missing it, and what to expect going forward.
The "Lowering MI Costs Plan"
To understand why this is such a big deal, we must look back at 2011. That year, Michigan overhauled its tax code and effectively created a "retirement tax," significantly reducing the amount of pension and IRA income that could be shielded from state taxes.
Fast forward to 2023. The state passed the Lowering MI Costs Plan, which was designed to roll back those 2011 tax hikes. But instead of flipping a switch overnight, the state decided to phase in the relief over four years.
Source: Michigan Employees’ Retirement System
This slow rollout is exactly why so many people are confused. For the last few years, the tax break has been age dependent. But starting in tax year 2026, the full benefit arrives for everyone.
The 2025 Numbers
Before we get to the full 2026 rollout, it is important to realize that you may already qualify for significant relief this year.
For the 2025 tax year, the state allows you to subtract up to 75% of the full deduction limit if you were born between 1946 and 1966.
- Single Filers: You can subtract roughly $49,423 of qualifying retirement income.
- Joint Filers: You can subtract roughly $98,846 of qualifying retirement income.
If you were born before 1946, you generally have even more flexibility, often qualifying for the full private deduction limits immediately, on top of full exemptions for public pensions.
This means that right now, in 2025, a married couple could potentially pull nearly $100,000 from their IRAs and pay zero Michigan income tax on it.
The 2026 Numbers
By the time you file your 2026 tax return, the new law will allow all qualifying retirees to subtract a massive chunk of their retirement income from their Michigan taxable income.
Based on the inflation-adjusted projections, the maximum subtraction for private retirement income (like IRAs and 401(k)s) is expected to be roughly:
- ~$69,896 for single filers
- ~$139,792 for joint filers
(Note: These figures are estimates based on inflation adjustments to the 2025 base limits of $65,897 / $131,794. The state will publish the final confirmed numbers closer to the start of the tax year.)
This means if you and your spouse withdraw $100,000 from your IRAs in 2026 to fund your lifestyle, you could potentially owe zero state income tax on that money. Under the old rules, a significant portion of that withdrawal would have been taxed at 4.25%, costing you over $4,000.
The "Gotchas"
While this is great news, it is not a free-for-all. There are specific rules about what income qualifies for this subtraction, and this is where people get tripped up.
- It's Not Automatic for Everyone: You have to qualify. Generally, this applies to distributions from qualifying retirement plans.
- What counts: Most distributions reported on a federal 1099-R form will qualify. This includes income from defined benefit pensions, private IRAs, and most 401(k) or 403(b) plans.
- What DOESN'T count: Income from non-retirement savings, such as standard brokerage accounts, interest from bank accounts, or capital gains from selling stock outside of a retirement wrapper, does not qualify for this specific deduction.
- The "Employee Contribution" Trap: Withdrawals from 401(k) plans that were funded only by employee contributions may not qualify. However, most employer plans that include a match or profit-sharing component generally do qualify. This is a technical detail that requires looking at how your plan is structured.
- Early Withdrawals: If you take money out before you were eligible to retire under your plan's specific rules (often age 55 or 59½), that income might not qualify for the subtraction.
- The "Under 60" Question: If you retire early and start drawing a pension before age 60, does it count? Generally, yes. The new 2026 rules state that "regardless of year of birth," taxpayers may deduct benefits. However, the distribution itself must still be "qualified." Usually, if you are collecting a regular pension check (defined benefit plan), it qualifies regardless of your age. But if you are pulling from an IRA or 401(k) before age 59½, you may face hurdles unless you meet specific exceptions. This is a gray area where personalized professional tax advice is essential.
- Public vs. Private: If you have a public pension (like from the state of Michigan or a public school), those benefits are often fully exempt already. The new deduction limits apply primarily to your private sources of income, like IRAs and 401(k)s.
So What?
Here is the practical takeaway: If you have 4.25% withheld from your monthly pension or IRA checks, you’re likely overpaying and can look forward to a larger than normal refund.
We recommend getting with your CPA or tax professional to review your current situation. They can help you determine if you should file a new MI W-4P form to adjust your withholding based on these new 2026 limits.
(Disclaimer: We are not licensed tax professionals. Always consult with a qualified tax advisor regarding your specific tax situation.)
Disclosures
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.