A new law governing how retirement income will be taxed starting in 2012 sets up a three-tier system, depending on a retiree's age. All three tiers avoid taxing Social Security income and military pensions. For couples, the age of the older spouse applies. Here's how the system works:

• Residents born before 1946 will continue to get the same tax breaks they have now. Public pensions will not be taxed. Income from private pensions, 401(k)s and IRAs will not be taxed on amounts up to $45,120 for single filers and $90,240 for joint filers. This will affect about 480,000 tax returns.

• Residents born between Jan. 1, 1946, and Dec. 31, 1952, will have all retirement income liable to tax, whether it's from a public or private pension, 401(k) or IRA. Exemptions can be claimed for up to $20,000 for a single filer and up to $45,000 for joint filers. Above those levels, retirement income will be taxed at the state income tax rate of 4.35 percent. When these residents turn 67, the $20,000/$40,000 exemption applies to all income, not just retirement income. If household resources exceed $75,000 for a single return or $150,000 for a joint return, the $20,000/$40,000 exemption is eliminated. The exemption also is eliminated if a taxpayer claims a deduction for a military or railroad pension. This will affect about 230,000 returns.

• Residents born after 1952 will see all retirement income taxed as regular income until they turn 67, at which point they'll qualify for a senior income exemption of $20,000 for single filers and $40,000 for joint filers on all income. If household resources exceed $75,000 for a single return or $150,000 for a joint return, the $20,000/$40,000 exemption is eliminated. A taxpayer can forgo the $20,000/$40,000 exemption and instead deduct 100 percent of Social Security income. A taxpayer claiming the $20,000/$40,000 exemption can't claim the deduction for Social Security or the standard personal exemption. This will affect about 150,000 returns.

Sources: Senate Fiscal Agency, Treasury Department