Does Pennsylvania Charge Income Tax on Early IRA Withdrawal?

Generally, Pennsylvania (PA) does not usually tax retirement distributions. However, the PA tax on IRA withdrawal rule only applies if you have reached retirement age when you begin to withdraw your money. On the other hand, if you make early withdrawals before you reach the set minimum withdrawal age, the state of Pennsylvania may tax you, usually at a rate of ​3.07 percent​, provided you are not taxed as a corporation. But that is not always the case with other states.

Which States Do Not Tax IRA Distributions?

Several states do not tax IRA distributions for the simple reason that they have no state income tax. But some states do make exemptions for retirement distributions. If you are considering where to settle in retirement to reduce your taxable income, you would be wise to explore such locations. Below are the nine states that have no state income taxes:

  • Florida
  • Texas
  • Washington
  • Tennessee
  • Wyoming
  • Alaska
  • Nevada
  • New Hampshire
  • South Dakota

In addition, the states below specifically do not tax 401(k), IRA and pensions distributions:

  • Pennsylvania
  • Mississippi
  • Illinois

It’s also worth knowing that some states partially tax retirement income. In such cases, the states don’t tax pensions but do tax distributions from qualified plans such as 401(k) s and IRAs. They include:

  • Hawaii
  • Alabama

How to Avoid PA Tax on IRA Withdrawals

If you don’t want your PA IRA distribution taxable, you should ensure you adhere to the set guidelines. Here are some rules you should observe:

  • For your IRA withdrawals to be tax-free in PA, you must wait to receive them until you reach ​59.5 years​ of age.
  • If an IRA participant dies and the distributions from that account are paid to a beneficiary or that person’s estate, the PA tax on IRA withdrawals will not apply.

When Does PA Tax Early IRA Distributions?

Despite the general rule that enables retirees to enjoy their IRA withdrawals untaxed within Pennsylvania, limits do exist. It would be prudent to learn what these limits are because they are sometimes at odds with the general rules on IRA distributions.

Below are some of the things you should know:

1. Substantially Equal Periodic Payments (SEPPs)

Typically, you could get around the early IRA withdrawal rule by employing the substantially equal periodic payments (SEPPs) strategy. According to this rule, if a qualified plan is eligible under rule 72(t), you could schedule regular annual payments over ​five years​ or until you reach 59.5 years without missing a single installment.

If you miss taking out an installment from your IRA, you will pay an early withdrawal penalty for all the monies you have already taken out.

The strategy is incompatible with the plan of your current employer. In addition, you must pay income tax on the funds you have never been taxed on.

The strategy usually allows you to get away without paying the penalty when making early withdrawals. But in PA, those taxes must be paid even if you are retired and do things the correct way.

2. The Minimum Age Requirement

If you begin to withdraw your money from an IRA before the age of ​59.5 years, some of your distributions will be subject to PA taxes. And the state of Pennsylvania will use the cost-recovery method to determine which part of your distributions will be considered taxable income.

Under the cost-recovery method, you will be allowed to “recover” all the contributions you made to your IRA before reporting your taxable income. For example, if you paid $400 for 80 months, your total contributions will be $32,000.

So, if you took an early distribution lump sum of $40,000, after recovering your costs, your taxable income in PA will be $8,000. If you recover all your contributions before reaching the required minimum withdrawal age, the subsequent distributions will be taxed fully until you hit that age.

3. Excess Distributions

According to Pennsylvania law, if you withdraw funds that exceed your previously taxed contributions, that excess amount will be taxable.

4. Charity Distributions

Non-retirement distributions, such as charity distributions, are taxable in PA as personal income. But the state will use the cost-recovery method to determine the taxable portion of your distribution.

The general rule of thumb is that PA does not tax IRA distributions so long as you fulfill the set requirements of the state. However, if you withdraw your money early, even if you legally avoid the ​10 percent​ penalty, PA may still charge you income tax. So, you need to be careful when withdrawing funds from your IRA accounts. And consider filing taxes via the PA-40ESR (I) form to account for your estimated taxable distributions.