IRAs, or individual retirement accounts, make excellent investment vehicles to get you on the road to a comfortable retirement. But how you're taxed on IRA withdrawals varies from state to state. While Kentucky, for instance, is a tax-friendly state for retirees, changes in state tax law as of 2018 mean it’s not as friendly as it used to be.
As of 2018, Kentucky taxes all pension income, including traditional IRAs, at 5 percent once an exemption threshold of $31,110 is passed.
State Taxation of IRA Distributions
Kentucky does tax withdrawals on traditional IRAs if they are above the state’s exemption limit, although there is no tax on Roth IRA distributions, which are also federally tax-free. Many Kentuckians will not have to pay taxes on IRA distributions because their combined retirement income does not meet the state’s pension exemption limit, but a significant number will pay more in tax.
Kentucky Retirement Taxes
While Kentucky does tax qualifying IRA distributions, it does not tax Social Security or Railroad Retirement benefits. The exclusion limit applies to qualified pension plans, annuities and military and civil service retirement income. However, those who retired from the military prior to 1997 do not have their retired military pay taxed. Kentucky does not have an estate tax, but it does have an inheritance tax. The inheritance tax only applies to those who are not Class A beneficiaries, such as spouses, children, grandchildren, siblings or parents.
2018 Kentucky Retirement Income Exclusion
In April 2018, Kentucky passed a tax reform package that did away with its former varied tax rate in favor of a 5 percent tax on all income. While tax reform benefits those who were formerly subject to the top 6 percent rate, it does negatively affect retirees because the amount of their income shielded from tax was reduced considerably. As of 2018, the exemption is $31,110 annually from any qualifying retirement plan. For example, the average Kentucky Teachers’ Retirement System pension is $37,000, according to the Lexington Herald Leader, which means the average retired teacher will pay taxes on their pension in 2018 even though they did not have to do so in previous years. The new tax bill cuts other state tax deductions, including medical insurance and medical expenses. Knowing the loss of roughly a quarter of the pension exemption was politically perilous, Governor Matt Bevin tried to veto the reform package, but because the state’s budget outlook was so fraught, legislators were able to override his veto.
- State of Kentucky: 1099R and Tax Information
- Forbes: Senior Specials: 14 States With Retirement Income Tax Break
- Retirement Management Services LLC: Kentucky Pension Exclusion 2018
- Harding,Shymanski & Company PSC: New Kentucky Tax Law Brings Significant Changes
- Kentucky Department of Revenue: Inheritance & Estate Tax