Wait, Democrats and Republicans can actually agree on something? Well, every Democrat and Republican running for governor of Michigan at least. The Michigan “Pension Tax”, is so unpopular with Michigan retirees, that it actually brought together people on both sides of the political spectrum. Democrat Gretchen Whitmer and Republican Bill Schuette both campaigned for eliminating the pension tax during the 2018 governor race. Governor Rick Snyder implemented the “retirement tax” after he was elected governor in 2011. The Michigan pension tax started taxing retirement account withdrawals and pensions payments that were previously exempt for retirees. So, when Gov. Whitmer announced her proposal to eliminate the pension tax last week you would expect it to be met with a lot of praise. Not exactly. In fact, for some retirees, her recent announcement may actually raise taxes! This article analyzes the recent proposal to eliminate the Michigan pension tax.
The Michigan Pension Tax
During the 2018 gubernatorial race, you couldn’t go five minutes without another commercial promising to eliminate the pension tax. Or, if looking for full effect, the Michigan “Retirement Tax”. So, what is this pension tax? Depending on your age, a Michigan retiree may have to pay state taxes on retirement account withdrawals and/or pensions. The Michigan state tax rate is currently 4.25%.
Here is a breakdown of how pensions and retirement accounts are currently taxed based on when you were born. Although we don’t have all of the details, the new proposal would eliminate all state taxes on pensions and retirement withdrawals for retirees.
|Year you were born||Pension and Retirement Withdrawals Tax-Free|
|Prior to 1946||Single: $51,570
|Between 1946 and 1952||Single: $20,000
|After 1952||All income is subject to taxation|
Source: State of Michigan
A few notes.
- Remember, you don’t pay any Michigan taxes on social security
- There is a good chance that you are paying no state income taxes if you were born before 1946 because of the large exemption
- If you were born between 1946 and 1952, you also may be paying very little or no state taxes because up to $40,000 of income is exempt if married
- The people who would most benefit from eliminating state taxes on pensions and 401(k) withdrawals are people born after 1952 (67 years old and younger in 2019)
- If most or all of your income is from social security, eliminating the pension tax won’t do you much good
Even though not everyone will benefit from getting rid of the pension tax, it wouldn’t hurt, right? Not so fast. Eliminating the pension tax may be beneficial, but the increase in other taxes may offset any benefit that you may receive.
The new gas tax
The reduction in the Michigan pension tax may benefit some retirees, but the new gas tax will certainly hurt the wallet of every retiree. Well, unless you are driving a Chevy Bolt or Tesla. In order to help fix Michigan’s swiss cheese roads, Gov. Whitmer has proposed an additional 45 cent per gallon tax on gas. Michigan is already the most expensive state in the country to insure a car, and now it may be one of the most expensive to buy gas.
Here is how the additional tax will hurt you based on your car’s MPG and how much you drive each year.
|Car MPG||Annual Miles Driven||Additional Tax|
This is the reason that Michigan retirees aren’t jumping for joy that the Michigan pension tax may go away.
So, will eliminating the Michigan pension tax help me?
If nothing else, it will certainly make the life of a financial planner and tax preparer here in the state of Michigan easier. Having different rules for the same amount of income but born in different years, just simply doesn’t make sense. The truth is that eliminating the pension tax should benefit most retirees. The people that will benefit the most are those born after 1952 and those with large pensions and retirement withdrawals. The people that probably won’t benefit, and will probably pay more because of the additional gas tax are those born prior to 1946 and those retirees that main source of income is social security. The truth is that most people will probably pay at the most $400 or $500 per year in the additional gas tax. It only takes about $10,000 of taxable income to pay that same amount of Michigan state taxes. In all likelihood, most younger retirees will have no problem saving that much in state income taxes by eliminating the Michigan pension tax.
However, if you are a retiree with a large Michigan tax bill, you may not want to get too excited. Both the elimination of the Michigan pension tax and increase in the gas tax are just proposals. There is a very good chance that we will be seeing the “eliminate the Michigan pension tax” commercials again during the next Governor election.
Disclaimer: I’m a financial advisor, but probably not your advisor and don’t know your complete financial picture. Therefore, please use this as education only and I strongly suggest talking with your financial advisor or tax preparer before implementing any of the above strategies.