Indiana uses the taxpayer's federal adjusted gross income to calculate the amount of state tax owed. Because of this, the addition of funds to an IRA lowers the taxable income and the withdrawal of funds increases it. There is no additional penalty beyond the federal penalty for early withdrawal from an IRA in the state of Indiana.
Unlike a Roth IRA, you deduct invested funds in a traditional IRA from your income the year in which you invested the money. If you have no employer sponsored plan, you can put the full amount -- $5,000, or $6,000 if you're over 50 years old -- into the plan, or up to the amount of earned income you had for the year if that amount is less.
There are income restrictions if you or your spouse has a retirement plan through your employer. For single or head of household status, the limit is $56,000 for a full $5,000 deduction and $66,000 for a partial deduction. If your status is married filing jointly,you can earn $89,000 for the full deduction or $109,000 for a partial deduction. Married filing separately status, meanwhile, receives a partial deduction up to $10,000 of income with no deduction after that amount. Finally, the amount you can earn if you're married filing jointly and only one spouse has a plan is $166,000 for the maximum contribution and $177,000 for a partial contribution.
Indiana is an AGI state, which simply means that the state uses the figures from the federal form to calculate income. This means that any federal exemptions or itemized deductions on the second page of the federal tax form are not considered part of your income. Since the IRA deduction or addition is included in the federal adjusted gross income, it affects the reportable income to the state. As a result, by investing in a traditional IRA you save 3.4 percent state tax on the money in addition to any tax that might be levied by your county government.
If you withdraw funds from a traditional IRA before you reach the age of 70 1/2, you will be required to pay a 10 percent penalty. However, there is no state tax penalty on this money.
For those not taking a required minimum distribution (RMD) from their traditional IRA by the age of 70 1/2, the federal government applies a 50 percent excise tax on the amount you should have taken. Indiana has no tax penalty for failure to remove the required minimum distribution.