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Last updated 10:54PM ET
April 18, 2021
Alabama Taxes Retirement Income Differently
(APR - Alabama Public Radio ) - Alabama doesn't levy any state income tax on traditional pensions, but it does tax 401(k)s and other defined contribution retirement plans.

State officials agree that's an inequity in Alabama's tax system, but they disagree about how to address it.

Gov. Bob Riley proposed a tax break for 401(k)s in the last session of the Legislature, but it went nowhere because it would reduce income taxes that fund public schools and colleges.

Alabamians now collect about $3.5 billion a year from government and corporate pensions, and the state taxes none of it, state Revenue Commissioner Tom Surtees told The Birmingham News.

If the state taxed it all, retirees collecting pensions would pay about $172 million a year more in income taxes, the state Revenue Department estimates.

Alabamians also collect about $2 billion a year from 401(k)s, individual retirement accounts, and other taxable defined-contribution plans, Surtees said.

People pay about $100 million a year in state income taxes on money they collect from those plans, the department estimates. The state's maximum income tax rate is 5 percent.

Defined benefit retirement plans, where a retiree receives a set annual payment based on their working income and years of service, have been free of state income taxes since the early 1990s. That includes the state pensions received by retired state workers and education employees.

In recent years, many companies have begun phasing out their traditional pension plans and offering their employees 401(k)s instead. With these plans, the employee and sometimes the employer makes a defined contribution for investment, but there is no guaranteed benefit. That depends on how the investments perform.

Riley said it would be "too big a hit" for the state to lose $100 million a year in income-tax collections by exempting all income from 401(k)s and other defined contribution plans.

Instead, he wants to resurrect his bill from the last legislation session that would exempt as much as $10,000 per year for those with adjusted gross incomes of less than $75,000 annually for singles and $150,000 for couples. Riley's plan would cost the state about $42 million a year.

State Sen. Hank Sanders, chairman of the Senate education budget committee, said he opposes Riley's plan because $42 million would be too big of a hit for public education.

He proposed capping the exemption for a pension to the first $10,000 or so per year. He said taxing pension income that exceeded such a cap could pay for a new exemption for 401(k)s and other defined-contribution plans, set at the same cap of $10,000 or so per year.

Sanders, D-Selma, said the changes would be fairer than the state's current tax policy.

"We could treat 401(k)s the same as pensions, and we'd meet the fairness level," Sanders said. "But we would also not take money from the Education Trust Fund."

Riley said he said he would oppose cutting the current pension exemption. "The last thing we need to do is impose an additional burden on the retirees in this state," he said.

Rep. Richard Lindsey, chairman of the House education budget committee, said he favors treating all retirement benefits equally and would like to see a compromise emerge when the next legislative session begins Feb. 5.

"I would certainly hope that we would look at that more seriously and more favorably as people do become more dependent upon 401(k)s and those type retirement benefits," Lindsey, D-Centre, told The Birmingham News.

Nationwide in March 2006, 51 percent of private sector employees participated in some type of retirement plan through their employer, according to the U.S. Bureau of Labor Statistics. The bureau reported that 20 percent had traditional pensions and 43 percent had 401(k)s or other defined contribution plans. Those numbers add up to more than 51 percent because some workers had both types of pension plans.


Information from: The Birmingham News

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