How Taxes Change in Retirement: An Illinois Resident’s Reality Check (With a Second Home in Florida)

One of the biggest misconceptions about retirement is that your tax bill automatically drops the day you stop working. For many people it does fall—sometimes dramatically—but the rules, income sources, and planning opportunities shift in important ways. Understanding those shifts can save six figures over a multi-decade retirement. This updated look focuses on an Illinois resident who also owns a second home in Florida. 

Key Ways Taxes Differ in Retirement

During your working years, most income arrives as W-2 wages. That means ordinary income tax rates apply to nearly everything,  you pay Social Security and Medicare (FICA) payroll taxes, withholding is automatic, and high earners often face phase-outs and the net investment income tax (NIIT).

In retirement the picture changes:

• Income sources are taxed differently. Traditional 401(k)/IRA withdrawals and qualified annuity payments are ordinary income federally. Qualified dividends and long-term capital gains get preferential 0%/15%/20% federal rates.   Roth withdrawals (if rules are met) are tax-free.

• No FICA taxes on retirement-account withdrawals, pensions, annuities, dividends, or capital gains.

• You control the timing and amount of many withdrawals (until required minimum distributions begin at age 73).

• New or enhanced senior deductions apply federally (standard deduction plus age add-ons, plus a temporary extra $6,000-per-person senior deduction for 2025–2028 that phases out at higher incomes).

• Medicare premiums can jump via Income-Related Monthly Adjustment Amount (IRMAA) surcharges based on modified adjusted gross income from two years earlier.

• Estimated taxes become your responsibility.

• State taxes become a major variable—especially in Illinois.

Illinois State Tax Treatment

Illinois has a flat 4.95% individual income tax rate. Critically for retirees, Illinois offers one of the most generous retirement-income exemptions in the country:
It fully subtracts (exempts) the federally taxable portion of distributions from qualified plans, including 401(k)s, traditional IRAs, and qualified annuities/pensions. There is no age requirement and no dollar cap.

 Social Security is also fully exempt.

 However, Illinois does tax other income—qualified dividends, interest, capital gains, rental income, and wages—at the full 4.95% rate. There is no preferential state rate for long-term capital gains or qualified dividends. Illinois uses personal exemptions (roughly $2,925 per person in 2026, plus an extra amount for age 65+) rather than a standard deduction; these phase out only at very high AGI levels ($500,000 for joint filers).

The Florida Second-Home Angle

Florida has no state income tax. Owning a second home there does not by itself change your tax residency. Illinois determines residency based on domicile—the place you intend as your permanent home. If your primary residence remains in Illinois and you maintain significant ties there (driver’s license, voter registration, time spent, etc.), you stay an Illinois resident and continue to pay Illinois tax on non-exempt income such as dividends and capital gains.

Many Illinois retirees eventually explore a full residency change to Florida. That requires clear actions: obtaining a Florida driver’s license and voter registration, filing a Declaration of Domicile, registering vehicles in Florida, updating legal documents, and typically spending more time in Florida while severing strong Illinois ties. 

A second home alone is treated as a vacation property and does not trigger the change. Property taxes also differ: Illinois has relatively high property taxes, while a Florida second home does not qualify for the homestead exemption (reserved for primary residences).

A Concrete Example: Just-Retired Illinois Couple, Age 65  

Meet a hypothetical couple who just retired at age 65. They are married, filing jointly, Illinois residents with a second home in Florida. 

Their profile:

• Spending need: $18,000 per month ($216,000 per year) after taxes.
• $2 million in a traditional 401(k).
• Qualified annuity paying $3,000 per month ($36,000 per year)—fully taxable as ordinary income federally and exempt from Illinois tax.
• $1,000 per month ($12,000 per year) in qualified dividends from a taxable account.
• Total net worth: $6 million.
• Pre-retirement income: $500,000 W-2 Income

Pre-retirement Taxes  (approximate):

On $500,000 of wages they would owe roughly $102,600 in federal income tax plus about $20,900 in FICA, for a combined federal burden near $123,500 (effective rate around 25%), plus Illinois tax on the full amount at 4.95%.In the first full year of retirement:
 

Fixed income = $36,000 (annuity) + $12,000 (qualified dividends) = $48,000.
 

To cover the $216,000 spending need they need roughly $202,600–$203,000 in 401(k) withdrawals.

That produces:

• Federal AGI of about $250,600–$251,000.

• Federal deductions of roughly $41,500 (standard deduction + age add-ons + partially phased senior deduction).

• Federal taxable income roughly $209,000 → federal income tax ≈ $34,600–$35,000 (mostly in the 22% bracket, with the $12,000 of qualified dividends taxed at the preferential 15% rate). A small amount of NIIT may apply once AGI exceeds $250,000. No FICA.

• Illinois tax: Only the $12,000 of qualified dividends is taxable at 4.95% (≈ $594). The entire $36,000 annuity and ≈ $203,000 of 401(k) withdrawals are fully exempt under Illinois’s retirement-income subtraction. Personal exemptions further reduce any residual liability.

• Combined federal + Illinois tax ≈ $35,200–$35,600.

Net cash available: ≈ $216,000—the amount needed for spending. Their effective combined tax rate on total gross income drops dramatically compared with their working years.

Medicare IRMAA and the Appeal Process

Because their 2024 income was high ($500,000), they will initially face elevated IRMAA surcharges on Medicare Part B and Part D premiums in 2026 (the two-year lookback). 

For a joint filer in the higher brackets, this can add hundreds of dollars per month per person.

Retirement qualifies as a “life-changing event” (specifically, work stoppage). They can request a new initial determination from the Social Security Administration using Form SSA-44. 

Supporting evidence typically includes a letter from the former employer confirming retirement, an estimate of current or expected MAGI, and related documentation. 

If approved, SSA recalculates IRMAA based on the lower post-retirement income rather than the old tax return. This can reduce or eliminate the surcharge going forward (and sometimes produce refunds for months already paid). 

Act promptly after receiving the IRMAA determination notice—generally within 60 days.

Bottom Line and Planning Takeaways

For this Illinois couple, the shift from a $500,000 W-2 to a mix of exempt retirement distributions, a modest amount of taxable dividends, and controlled 401(k) withdrawals produces a large drop in both federal and state tax.

 Illinois’s broad retirement-income exemption is a major advantage while they remain residents. The Florida second home offers lifestyle flexibility and a potential future path to eliminate state tax on investment income entirely if they later establish Florida domicile.

Other levers include:

• Sequencing withdrawals and considering Roth conversions in lower-income years.

• Managing MAGI to control future IRMAA brackets and the federal senior-deduction phase-out.

• Evaluating a full residency change to Florida if the tax savings on dividends, capital gains, and other non-retirement income justify the move.

• Monitoring property-tax differences between the Illinois primary home and Florida second home.

Taxes in retirement are rarely “set it and forget it.” 

The combination of ordinary-income sources, preferential federal rates, the disappearance of payroll taxes, Illinois’s retirement exemptions, Medicare IRMAA rules (and the appeal process), and multi-state residency considerations creates both complexity and opportunity.

Every situation is unique—consult a tax professional or financial planner familiar with Illinois and multi-state issues who can run projections with your exact numbers. The transition from high earner to retiree is one of the most powerful tax-planning windows most people ever get—use it wisely.

For over 20 years,    John and his team have been helping successful individuals and their families,  plan,  preserve, protect, and pass on their hard earned wealth.  

​Based in Naperville, Illinois, John serves clients in Naperville, Plainfield, Darien,  Aurora, Geneva, St Charles, and throughout the United States.  

Learn more about John's services by visiting  https://www.stantongwp.com/team-member-01  or connecting with him on LinkedIn  https://www.linkedin.com/in/john-stanton/ 

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