Are 401(k) Withdrawals Taxable in Iowa?

Retirement taxation in Iowa has recently shifted, impacting how retirees access their 401(k) funds. For many individuals, withdrawals from these plans are no longer subject to state income tax. This change, however, comes with specific conditions and eligibility requirements. Understanding these rules is necessary for anyone planning to draw upon their retirement savings while residing in the state.

Iowa’s Retirement Income Exclusion

Beginning with the 2023 tax year, Iowa enacted a law that changed its approach to taxing retirement income. This legislation allows qualifying taxpayers to exclude certain retirement plan distributions from their state income tax calculations. This exclusion is a state-specific benefit and has no bearing on federal tax obligations.

Retirees must still account for their 401(k) withdrawals on their federal income tax return, where the distributions are taxed as ordinary income. The Iowa law operates independently of IRS regulations.

Qualifications for the Tax Exclusion

To benefit from Iowa’s retirement income exclusion, an individual must meet one of three specific criteria on the last day of the tax year. The most common path to eligibility is based on age; individuals who are 55 years of age or older qualify to exclude their retirement income from state taxation. This age-based requirement applies regardless of whether the individual is still employed.

A second path to eligibility is through disability. An individual who is totally and permanently disabled can also take advantage of the tax exclusion, regardless of their age.

The final qualification route is for a surviving spouse or a survivor with an insurable interest. If an individual inherits a retirement account from a deceased person who would have qualified for the exclusion based on age or disability in the year of their death, the survivor is also eligible to exclude withdrawals from that inherited account from their Iowa income tax.

These three distinct pathways—being age 55 or older, having a qualifying disability, or being a qualifying survivor—are the sole determinants for individual eligibility.

Covered Retirement Income Sources

The Iowa tax exclusion applies to a broad range of retirement plans. Withdrawals from employer-sponsored defined contribution plans, such as traditional 401(k)s, are covered under this rule. This means that distributions taken from these accounts by a qualifying individual are not subject to Iowa income tax.

The favorable tax treatment also extends to distributions from:

• Traditional and Roth Individual Retirement Arrangements (IRAs)
• 403(b) plans
• SEP and SIMPLE IRAs
• Governmental and private pension plans
• Annuities
• Various deferred compensation plans

Taxation for Non-Qualifying Withdrawals

When a 401(k) withdrawal is taken by an individual who does not meet Iowa’s eligibility criteria, the tax treatment is entirely different. For example, a person under the age of 55 who is not disabled and takes a distribution will find that the entire amount is subject to state income tax. In this scenario, the withdrawal is treated as ordinary income and is taxed at Iowa’s applicable income tax rate for that year.

This state income tax is levied in addition to any federal taxes and penalties. For non-qualifying early withdrawals, the IRS imposes a 10% penalty on top of federal income tax. Therefore, an Iowan under 55 taking an early distribution could face a reduction in their net proceeds due to both federal and state tax obligations.