For most retirees, retirement distributions are not taxable in Pennsylvania. The state’s flat 3.07% income tax exempts distributions from qualified retirement plans once you meet the plan’s age or service conditions, and Social Security benefits are excluded entirely. The exemption is broader than the federal rules, so money that shows up as taxable on your federal return is often fully tax-free for Pennsylvania purposes. The main situations where you will owe PA tax are early withdrawals and payments from non-qualified deferred compensation plans.
When Employer Plan Distributions Are Exempt
Distributions from a 401(k), 403(b), traditional pension, SEP, SIMPLE, Keogh, or other plan qualified under Section 401(a) of the Internal Revenue Code are exempt from Pennsylvania income tax when two conditions are satisfied.1Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation First, the plan must be an “eligible Pennsylvania retirement plan,” meaning it ties eligibility to age, disability, or length of service and pays out at regular intervals after separation from service, continuing at least until death.2Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation Most mainstream employer plans clear this bar. Second, you must have separated from service after either reaching the plan’s stated retirement age or completing its required years of service.
Direct rollovers between qualified plans, such as moving a 401(k) balance into an IRA, are not distributions for PA purposes. The money keeps its tax-deferred status and nothing hits your return.3Commonwealth of Pennsylvania. Personal Income Tax – Tax Types and Information
IRAs and Roth IRAs
IRAs work a little differently because there’s no employer to separate from. Pennsylvania treats an IRA distribution as exempt retirement income as long as you wouldn’t owe a federal early withdrawal penalty on it. In practice, that means the exemption applies once you reach age 59½, or at any age in the case of death or disability.1Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation
Roth IRAs follow the same rule. A Roth distribution taken at 59½ or later, from what qualifies as an eligible retirement plan, is not taxable in Pennsylvania. Earlier withdrawals are taxed under the cost recovery method described below.1Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation
Roth Conversions
Converting a traditional IRA to a Roth IRA generally does not trigger Pennsylvania tax, even though it usually creates federal tax. Money moved through a trustee-to-trustee transfer or a 60-day rollover is not a taxable event as long as the entire amount lands in the Roth. Anything withheld for federal tax or otherwise diverted before it reaches the Roth is taxable in PA, and a partial conversion allocates your basis proportionally between the two accounts.4Pennsylvania Department of Revenue. Personal Income Tax Preparation Guide PA-40 (DFO-02)
Early Withdrawals and the Cost Recovery Method
Taking money out before you meet Pennsylvania’s exemption criteria makes the distribution taxable as compensation at 3.07%. A 50-year-old who separates from service and cashes out a 401(k) owes PA tax on the payout. Federal penalty exceptions under IRC Section 72(t) are irrelevant to Pennsylvania. The state looks only at whether you’ve hit the plan’s retirement milestone.5Office of the Law Revision Counsel. 26 USC 72 Annuities Certain Proceeds of Endowment and Life Insurance Contracts
How much of an early distribution is actually taxable depends on the “cost recovery method.” Your own after-tax contributions come out first, tax-free, because you already paid tax on that money. Only after you’ve fully recovered your basis do the remaining dollars, representing employer contributions and earnings, become taxable.2Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation That’s different from the federal pro-rata approach, where each withdrawal mixes basis and earnings.
The same method applies to early Roth IRA withdrawals. Because Roth contributions are all after-tax, you can generally pull back everything you put in before any taxable amount arises. Early Roth withdrawals at the state level are often less painful than they are federally.1Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation
Social Security and Military Retired Pay
Social Security benefits are fully exempt from Pennsylvania income tax, no matter how much other income you have. Pennsylvania has no income-based phase-out, so the up-to-85% federal inclusion doesn’t carry over to your state return.3Commonwealth of Pennsylvania. Personal Income Tax – Tax Types and Information Military retired pay, including disability-related retirement pay, is also exempt.
Local earned income taxes levied by municipalities and school districts don’t apply to pension or retirement income either. The local tax reaches wages and net business profits, so even a taxable early distribution won’t create a local bill.6Pennsylvania Municipal Retirement System. Taxes
Non-Qualified Deferred Compensation Isn’t Covered
Non-qualified deferred compensation plans, the kind offered to executives through rabbi trusts or top-hat arrangements, get no retirement exemption. Pennsylvania treats NQDC payouts as compensation, taxable at 3.07% when received, regardless of your age or whether you’ve formally retired.1Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation The full distribution is taxable, including both the deferred amounts and their earnings, whether paid as a lump sum or in installments.7Pennsylvania Department of Revenue. Pennsylvania Personal Income Tax No. PIT-06-009 Distributions from Nonqualified Deferred Compensation Plan
Inheritance Tax on Retirement Accounts
Retirement income can still reach Pennsylvania through the inheritance tax after the account owner dies. Rates depend on the heir’s relationship to the decedent:
- Surviving spouse: 0%
- Children and direct descendants: 4.5%
- Siblings: 12%
- All other heirs: 15%, with charities and government entities exempt
The rate doesn’t necessarily apply to the full balance. For IRAs, only the contributions portion is generally subject to inheritance tax when the owner died before reaching the plan’s normal retirement age, because the earnings would have carried a federal early withdrawal penalty. For 401(k) accounts, taxability turns on whether the deceased had the right to terminate the plan during life, which most participants don’t have until normal retirement age. If the decedent was disabled at death, the entire balance is taxable regardless of age.9Pennsylvania Department of Revenue. Is a Decedents IRA or 401K Subject to PA Inheritance Tax
How to Report It on Your PA-40
Even exempt distributions have to appear on your Pennsylvania return. Every 1099-R must be recorded on PA-40 Schedule W-2S, in the section for pensions, profit-sharing plans, IRAs, SEPs, annuities, and other retirement plans, and copies of the 1099-R forms attach to the return.10Pennsylvania Department of Revenue. Wage Statement Summary (PA-40 W-2S) Skipping Schedule W-2S because a distribution is tax-free is a common mistake that can prompt the Department of Revenue to ask questions.
Taxable early distributions are reported as compensation on Line 1a of the PA-40. Distributions from annuity or endowment contracts that are taxable federally are treated as interest and go on Line 11 of PA Schedule A.4Pennsylvania Department of Revenue. Personal Income Tax Preparation Guide PA-40 (DFO-02)