Making the Most of the Maine Pension Income Deduction
The Maine Pension Income Deduction has provided a modest discount on Maine income taxes to retirees over the past decade. For most, Social Security benefits (which are already not taxed in Maine) exceeded the allowable deduction making it a moot point. But over the course of just three years the deduction has grown more than four-fold and is now larger than most retirees’ Social Security benefits, allowing the potential for a much more meaningful tax benefit.
Oh my, how you’ve grown!
The maximum allowable Maine pension income deduction in recent tax years:
2013 and prior = $6,000
2014 thru 2021 = $10,000
2022 = $25,000
2023 = $30,000
2024 = $45,864
The deduction is now tied to the maximum annual Social Security benefit available to someone retiring that tax year at full retirement age, and indexed for inflation. In 2024, that amount is $45,864. At a Maine marginal tax rate of 7.15%, that’s $3,279 of potential Maine tax savings!
It is important to know the deduction is an individual benefit. If married, you and your spouse may each deduct up to $45,864 of eligible income in 2024 for a total of $91,728, but the deduction cannot be shared between couples. It is a use it or lose it annual deduction; there is no carryover from one tax year to the next.
How does the Maine pension income deduction work with Social Security benefits?
Social security and railroad retirement benefits are not taxable in Maine, but they will reduce your allowable pension income deduction. For example, if an individual receives $24,000 in Social Security benefits in 2024, this uses up $24,000 of their pension deduction with $21,864 remaining for other eligible income.
Military retirement pay, including survivor benefits, are fully exempt from Maine income tax and will not reduce your allowable deduction.
Which types of pension income qualify?
Despite the deduction’s name, most types of retirement income are eligible, including:
- State pensions
- Federal pensions
- Employer pensions
- Distributions from 401(k), 403(b), and 457(b) retirement plans
- Distributions from Traditional IRA’s and Roth IRA’s (including SIMPLE IRA’s and SEP IRA’s)
Types of income that do not qualify include Roth conversions, 457(f) deferred compensation plans, and distributions taken from retirement accounts early and subject to the 10% federal penalty.
Only the individual who earned the income from their prior employment may utilize the deduction. However, a spouse receiving pension survivor benefits may take a deduction for that amount, up to their individual limit. This means distributions from a non-spousal Inherited IRA are ineligible for deduction.
Review Maine’s Form 1040, Schedule 1S, Worksheet for Pension Income Deduction for the relevant tax year to verify eligible income.
How can I maximize the deduction?
When saving for retirement, especially as a couple, keep this deduction in mind. Even if the household has a single earner, it benefits you as a couple to save retirement funds in both of your names. Opening an IRA and building savings in the name of the non-earning spouse will allow you to make the most of the individual deductions in retirement.
If you are nearing retirement or already retired, you may be able to optimize your retirement account distributions to maximize the deduction. Consider all your income sources and see if they are currently maxing out the annual deduction. If they are not, it may make sense to prioritize distributing funds from eligible pension sources over non-eligible sources to cover the rest of your spending needs. Again, this is especially true for couples, as shown in the example below.
This couple needs total income of $100,000 and they plan to distribute $35,000 from their IRAs. When determining which IRA to distribute from in 2024, this couple would be wise to consider how to optimize their income deductions.
All other factors aside, they could maximize their individual deductions by splitting their IRA distributions, such as a $10,000 distribution from Spouse 1 IRA and a $25,000 distribution from Spouse 2 IRA. If they had simply distributed $35,000 from the Spouse 1 IRA, they would be paying 7.15% Maine tax on $20,864 of income unnecessarily. That’s $1,492 of potential Maine tax savings!
Talk to your Advisor!
Retirement savings and income plans involve much more than trying to save on state income taxes. There is plenty of nuance here, so please reach out to your trusted advisor to discuss your individual situation. If you’re a retiree in a state other than Maine, check to see if your state offers a similar pension income deduction for tax planning opportunities!
