Does Pennsylvania Tax Pensions? IRAs, Annuities, and Social Security

Pennsylvania does not tax pensions or most other retirement income once you meet the state’s exemption rules. Distributions from employer pensions, 401(k)s, 403(b)s, and IRAs are all exempt from Pennsylvania’s flat 3.07% personal income tax when specific age or service conditions are satisfied.¹ Social Security, military retirement pay, and Railroad Retirement benefits are exempt with no conditions at all. The exemptions make Pennsylvania one of the more retiree-friendly states, but the rules differ from federal rules in ways that catch people off guard, particularly around early withdrawals and IRA rollovers.

Pensions, 401(k)s, and 403(b)s

Employer-sponsored retirement plan distributions are exempt when two things are true. The plan has to be an eligible retirement plan under the Internal Revenue Code, which covers defined benefit pensions, 401(k)s, 403(b)s, profit-sharing plans, money purchase plans, and government thrift savings plans.² And you must have separated from service and met the plan’s own age or years-of-service requirement for retirement.³

The plan’s governing documents set those thresholds, not the state. If your pension says you can retire at 55 with 30 years of service, that’s the standard Pennsylvania uses. You do not have to wait until 59½ or any federal age for penalty-free withdrawals. What matters is that your plan says you have met its retirement criteria and you have actually left the job.

The separation requirement is the piece people miss. Reach your plan’s retirement age, keep working, start taking distributions, and Pennsylvania treats the payments as taxable compensation rather than exempt retirement income. The exemption applies only after you leave.

Traditional and Roth IRA Withdrawals

IRAs follow a different rule because there is no employer to separate from. Pennsylvania treats an IRA distribution as exempt as long as the withdrawal would not trigger a federal early withdrawal penalty.² In practice that means distributions after age 59½ are exempt, along with distributions due to death or disability.

This is where the state and federal rules pull apart in a way that costs people money. Say you retire at 55 from a job with a 401(k) and roll the balance into a traditional IRA. Withdrawals from the 401(k) might have been exempt because you met the plan’s retirement criteria, but the same money in the IRA is taxable in Pennsylvania until you hit 59½. The rollover changed which exemption rule applies. Anyone considering an early-retirement rollover should think this timing issue through before moving funds.

Qualified Roth IRA distributions are exempt too. Because Roth contributions are made with after-tax dollars at both the federal and state level, qualified withdrawals come out completely tax-free. Roth 401(k) distributions work the same way.

Social Security, Military Pay, and Railroad Retirement

Three major retirement income sources are exempt from Pennsylvania income tax without any age, service, or plan-type conditions:

Social Security retirement and disability benefits are completely exempt, an advantage over states that tax Social Security above certain income thresholds.²
Military retired or retainer pay from any branch of the uniformed services is exempt regardless of the recipient’s age or length of service.⁴
Railroad Retirement Tier 1 and Tier 2 payments are exempt from state income tax.²

If you receive the benefit, it’s exempt. No plan criteria, no separation requirement.

Annuity Payments

Annuity treatment depends on where the annuity came from. Annuities purchased through an employer-sponsored retirement plan are exempt if the payments meet the definition of a qualified annuity, meaning equal or substantially equal periodic payments made at least annually over your lifetime, your life expectancy, or a period of at least 10 years.²

Annuities you buy on your own outside an employer plan are treated differently. Pennsylvania taxes the earnings portion of privately purchased annuity payments as interest income to the extent the payments exceed your original investment. The gain is reported on PA Schedule D using the cost-recovery method. Buying an annuity for retirement purposes does not, by itself, make the income exempt.

When Retirement Distributions Are Taxable

The most common reason retirement money becomes taxable in Pennsylvania is taking it out too early. For employer plans, that means withdrawing before you have both separated from service and met the plan’s retirement criteria. For IRAs, it means withdrawing before age 59½ when a federal early withdrawal penalty would apply.³

Even when a distribution is taxable, you often owe less than you might expect. Pennsylvania does not allow deductions for contributions to 401(k)s, IRAs, SEP plans, or similar accounts, so those contributions were already taxed at the state level in the year you earned them.⁵ When you take an early distribution, the state uses the cost-recovery method: you recover your previously taxed contributions first, and only the earnings portion is subject to the 3.07% tax.³ For someone who contributed heavily over a long career, a large share of an early withdrawal can come out as a nontaxable return of contributions.

Nonqualified Deferred Compensation

Nonqualified deferred compensation plans do not get the same favorable treatment as qualified plans. Distributions tied to elective deferrals are taxable as compensation when paid out, whether or not you are retired.⁶ If you can document that specific elective deferrals were previously taxed by Pennsylvania during certain transition years, those amounts can be excluded using the cost-recovery method, but the Department of Revenue requires substantiation.⁷ Amounts required to be included in federal gross income under IRC Section 409A are also treated as compensation for Pennsylvania purposes, even if the money was not actually paid out.

Local Earned Income Tax

Pennsylvania municipalities levy their own earned income taxes on wages. Retirement income that is exempt from the state personal income tax is also exempt from local earned income taxes.⁸ Your pension, 401(k), IRA, and Social Security payments will not generate a local income tax bill.

Inheritance Tax on Retirement Accounts

Pennsylvania is generous with income tax exemptions during your lifetime, but retirement accounts are generally subject to Pennsylvania inheritance tax when they pass to beneficiaries. Rates depend on the beneficiary’s relationship to the deceased:⁹

Surviving spouse: 0%
Direct descendants (children, grandchildren): 4.5%
Siblings: 12%
All other heirs: 15%

A parent inheriting from a child aged 21 or younger also pays 0%, and transfers to charities and government entities are exempt. The inheritance tax return is due nine months after the date of death, and estates that pay within three months receive a 5% discount on the amount owed.⁹

This gets overlooked. A $500,000 IRA passing to an adult child generates roughly $22,500 in Pennsylvania inheritance tax at the 4.5% rate, on top of the federal income tax the child owes on distributions. Naming a spouse as the beneficiary avoids the inheritance tax entirely. For non-spouse beneficiaries, the interaction between inheritance tax and income tax on distributions makes beneficiary designations one of the more consequential estate planning decisions for Pennsylvania retirees.

1
Commonwealth of Pennsylvania. Tax Rates
2
PA.gov. PA Personal Income Tax Guide – Gross Compensation
3
Commonwealth of Pennsylvania. Gross Compensation
4
The Official Army Benefits Website. Pennsylvania Military and Veteran Benefits
5
Pennsylvania Department of Revenue. PA Personal Income Tax Guide – Deductions and Credits
6
Pennsylvania Department of Revenue. Personal Income Tax Bulletin 2005-03 – Deferred Compensation Under Nonqualified Plans
7
Pennsylvania Department of Revenue. Pennsylvania Personal Income Tax No. PIT-06-009 – Distributions from Nonqualified Deferred Compensation Plan
8
Pennsylvania Municipal Retirement System. Taxes
9
Department of Revenue | Commonwealth of Pennsylvania. Inheritance Tax