Many states, including Pennsylvania, offer various tax breaks to retired taxpayers. While some states allow taxpayers to exclude pension income up to a certain amount, the total allowable exemption can vary. Depending on the state, exempt pension income may include federal, state and local government pensions, Social Security, some railroad retirement benefits, military benefits and private pensions.
Pennsylvania residents are not required to pay state personal income tax on retirement income from a qualified pension plan. A qualified pension program includes written provisions, establishes eligibility requirements, provides for payments at regular intervals following retirement and does not permit benefits to be distributed until employment is terminated, according to the Pennsylvania Department of Revenue. Employer-sponsored programs and other commonly accepted retirement programs qualify. Numerous other states allow taxpayers who receive retirement income to exclude at least a portion of the pension income they receive from their state taxable income. The purpose of retirement income exclusions is to reduce taxable income lowering a retired taxpayer's tax liability.
Retirement income exclusions formerly came about as a way to help retired public employees who received small pensions. Since then, tax provisions have evolved to safeguard the income of individuals who have retired from the labor force and are no longer based on public service. Many states that offer exclusions use age as a standard for excluding retirement income. In some states, taxpayers age 65 and older can take the deduction whereas residents in other states can exclude a percentage of retirement income beginning at age 62. Colorado allows taxpayers to exclude a portion of pension and annuity income at age 55. The state of Delaware also allows taxpayers younger than 60 to deduct eligible pension amounts. After age 60, the amount a taxpayer can exclude increases.
The types of retirement income eligible for tax exclusion vary among states but can include pensions, annuities, IRA accounts, 401k and other deferred compensation plans. Often disability retirement benefits and death benefits also qualify for exclusion. In states that allow retirement income exclusions, income you report on lines 15b or 16b on federal Form 1040 normally qualifies. Under Pennsylvania law, as long as you meet the eligibility requirements for retirement based on age, medical condition or years of continued service, your retirement is not taxable for Pennsylvania personal income tax.
Distributions made from IRA accounts are not subject to Pennsylvania income tax after the age of 59½. This includes lump sum distributions. If you withdraw money from the account before that age, you may have to pay taxes on some of the money even if you are retired. Although federal law may exempt you from paying an early withdrawal penalty, Pennsylvania tax law does not. Withdrawals from an IRA account are not taxable if paid to the deceased's estate or designated beneficiary.
- Bankrate.com; State Retirement Income Tax Breaks; Bell; November 2005
- Taxes In-Depth: Pennsylvania State Income Taxes
- National Conference of State Legislators; State Personal Income Taxes on Pensions and Retirement Income – Tax Year 2010; Snell; February 2011
- Pennsylvania Department of Revenue; What Is a Qualified Pension Program; January 2011
- Pennsylvania Department of Revenue; How to Determine If IRA Withdrawals Are Subject to PA Income Tax; September 2010