Is Interest Received on an IRA Taxable in Illinois?

by Mike Parker

There are many methods of setting money aside for your retirement years. If you earn wages from employment it is likely that you are contributing to the Social Security system. Many companies offer their employees the opportunity to contribute to a qualified retirement plan such as a 401(k). Most taxpayers can also contribute to an individual retirement account that provides specific tax benefits. Some states, including Illinois, do not include the proceeds from your individual retirement account as income for state income tax purposes.

Traditional IRA

A traditional individual retirement account (IRA) offers a number of tax benefits, including the ability for qualified taxpayers to deduct the amount of their contribution, up to specified limits, from their taxable income. Since your traditional IRA contribution is not included in your federal adjusted gross income, you will not pay Illinois income tax on those funds. Funds inside a traditional IRA are allowed to grow tax-deferred. You can begin taking qualified withdrawals from your traditional IRA once you reach age 59 1/2 years. The Internal Revenue Service (IRS) considers qualified withdrawals from your traditional IRA to be ordinary income. You must report this amount and pay taxes on it when you file your federal income tax return. The state of Illinois does not tax qualified distributions from your traditional IRA. You can deduct the amount of your qualified distributions from your income when you file your Illinois state income tax return.

Roth IRA

You must make contributions to your Roth individual retirement account with after-tax dollars. You may not take a tax deduction on your federal income tax return for contributions to your Roth IRA. Amounts you contribute to your Roth IRA are included in your federal adjusted gross income, so you will pay Illinois state income tax on these amounts. Qualified withdrawals from your Roth IRA are free from federal income taxes. You do not need to report qualified withdrawals from your Roth IRA when you file your federal income taxes, and they are not taxed as income by the state of Illinois.

Interest Inside an IRA

An IRA is a special type of holding account. It is not an investment, but it can contain a wide variety of types of investments, including stocks, bonds, mutual funds and bank certificates of deposit. Any income or growth that results from investments inside either a traditional IRA or a Roth IRA occurs without creating a taxable event, as long as the funds remain inside the IRA. This includes any interest paid by interest bearing investments or securities. The tax deferral applies to both Illinois state and federal income taxes.

Interest Outside An IRA

Qualified withdrawals from your retirement accounts are typically not considered taxable income for Illinois state income tax purposes, regardless of whether these distributions are taxable at the federal level. Once you receive funds from your retirement account, they are no longer afforded tax-deferred status. If you invest these funds into an interest bearing account or product, the income generated by those investments is considered taxable income.

About the Author

Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.

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