Arizonans who have been squirreling away money into tax deferred retirement accounts may get a cash bonus from the state.

On a party-line vote, the House Ways and Means Committee approved a plan to make distributions of up to $29,200 a year from an Individual Retirement Account exempt from state income taxes. Ditto payments from 401(k) retirement plans.

At the current 2.5% rate for individual income taxes, that translates to up to $730 a year for married couples filing jointly; single taxpayers would be able to save half that much.

And, if approved, it would take effect for the current year, meaning the deduction could be taken when people file their 2025 state tax returns in April 2026.

Sen. J.D. Mesnard, R-Chandler, is promoting his SB1371 as an incentive for people to put money aside into tax-deferred accounts while they are working, knowing that there won’t be a financial hit when they take the money out.

But Rep. Mariana Sandoval said there’s a flaw to that argument.

“It’s easy to say that this will encourage savings, this will allow more people to invest,” said the Goodyear Democrat. “But if people are living day to day and have no disposable income, it’s very hard for people to do that.”

And there’s something else.

Even with a cap on how much people can shield each year from state taxes, Mesnard’s legislation would reduce state revenues by an estimated $130 million a year.

The amount of that loss got the attention of Rep. Seth Blattman. The Mesa Democrat pointed out this comes as Gov. Katie Hobbs is asking state lawmakers to find $122 million to ensure that services are not cut for Arizona families who have children with developmental disabilities.

So far, though, Republican lawmakers have balked, saying they first want answers to what they say is the governor’s mismanagement of the budget. House GOP lawmakers even used a procedural maneuver on March 18 to block a vote on immediately providing the cash.

Mesnard, for his part, called that fight over funding irrelevant to his tax-cut proposal.

“It’s not like there’s a choice here that if we cut this tax for retirees that somehow makes DDD funding more vulnerable,” said the Chandler Republican. Mesnard said the state has a budget of close to $18 billion, leaving plenty of other places to cut spending, long before he would seek to cut that program. 

Even if it would not affect money for developmental disability programs, Blattman remained unconvinced.

“I don’t think the best use of finite resources is to have more money go to people who have been lucky enough to have retirement accounts,” he said.

What’s at issue here is the fact that federal and state law allows individuals to shelter some current income from taxes.

The most common method is to create an Individual Retirement Account. Current law allows individuals younger than 50 to put away up to $7,000 a year, with an $8,000 cap on those older than that. The funds in these accounts can be invested in a variety of ways.

Some employers also offer the option of what are called 401(k) accounts where workers can have a portion of their salary shielded from current income taxes to be withdrawn later.

What has been behind the concept has been the belief that individuals have lower tax liabilities when they retire, meaning the tax bite will be less when the money is withdrawn than if it had been paid when the money was first earned.

“But there’s no guarantee that’s the case — unless this bill passes,” Mesnard said.

He also said there is precedent for his plan.

Mesnard noted that Arizona does not tax Social Security income. And he said that the first $2,500 a year of public pensions, such as for state employees, also is exempt from state income taxes.

As originally crafted, his legislation would have made distributions exempt from state taxes beginning when people reached 59 1/2. Nor was there a limit on how much could be shielded, meaning that someone who had managed to amass a large retirement account would owe nothing to the state.

And Mesnard was even going to exempt contributions by those still working to Roth IRAs, which now are taxable, from state income taxes.

But all that came at a price tag of more than $900 million, something even Mesnard acknowledged was probably politically unacceptable.

Even if the cost in lost revenues to the state is just $130 million, supporters say that ignores some offsets — benefits beyond simply encouraging people to save in these tax-deferred accounts when they are younger.

“This will entice folks to move to Arizona which will improve and increase and grow our economy, something that’s beneficial to all Arizonans,” said Rep. Justin Olson, R-Mesa. “It will also entice young folks who are still working, and throughout their working years, to prepare for retirement so they don’t become a burden to society in their retirement age.”

The measure, which already has been approved by the Senate, now awaits a vote of the full House.