Does Colorado Tax IRA Distributions?

Distributions from traditional Individual Retirement Arrangements (IRAs) are generally taxable income in Colorado, as the state’s tax system starts with your federal taxable income. However, Colorado offers a tax benefit that can reduce or eliminate the state tax on this income for qualifying retirees. This benefit is known as the Pension and Annuity Subtraction.

The Pension and Annuity Subtraction

The primary mechanism for reducing state tax on retirement income is the Pension and Annuity Subtraction. This subtraction is available to all taxpayers who receive retirement income and meet certain age requirements. Eligibility and the amount of the subtraction are tiered based on your age as of the last day of the tax year. For taxpayers aged 55 to 64, up to $20,000 of qualified retirement income can be subtracted from their Colorado taxable income.

Once a taxpayer reaches age 65, the subtraction amount increases. Individuals aged 65 and older can subtract up to $24,000 of their retirement income. It is a single, combined subtraction that applies to the total of all pension, annuity, and traditional IRA distributions you receive. For this age group, any federally taxable Social Security benefits must also be included in this total, and the combined amount cannot exceed the $24,000 limit.

For example, if you receive income from a former employer’s pension and also take a distribution from your traditional IRA, you must add these amounts together before applying the single subtraction limit. This subtraction directly reduces the amount of income subject to Colorado’s flat income tax rate.

Calculating Your Colorado Taxable IRA Income

For a taxpayer under the age of 55, no subtraction is available, and the entire distribution from a traditional IRA is subject to Colorado income tax. The calculation changes significantly once you meet the age requirements for the subtraction.

Consider a 66-year-old individual whose only retirement income is a $22,000 distribution from a traditional IRA. Since this person is over 65, they are eligible for the full $24,000 subtraction. Because their total retirement income of $22,000 is less than the allowable subtraction, they can subtract the entire amount, resulting in no state taxable income from their IRA.

In another scenario, a 60-year-old taxpayer receives a $15,000 pension and takes a $15,000 IRA distribution, for a total retirement income of $30,000. This individual is eligible for the $20,000 subtraction for those aged 55 to 64. They would apply the $20,000 subtraction to their $30,000 total income, leaving $10,000 as the taxable portion of their retirement income for Colorado tax purposes.

Tax Treatment of Roth IRA Distributions

The tax treatment of Roth IRA distributions in Colorado is different from that of traditional IRAs. Colorado’s income tax calculation begins with the taxpayer’s federal adjusted gross income. Because qualified distributions from a Roth IRA are not included in federal taxable income, they are not taxed by Colorado.

A distribution is considered “qualified” if the Roth IRA has been open for at least five years and the owner meets certain conditions. These conditions require the owner to be over age 59½, disabled, or deceased. As long as these federal requirements for a tax-free withdrawal are met, the money comes out free of both federal and Colorado state income tax.

Reporting on Your Colorado Tax Return

To claim this tax benefit, you must report the Pension and Annuity Subtraction on a specific state tax form. The calculation is entered on the Colorado Subtractions from Income Schedule, which is form DR 0104AD. You will find a designated line on this schedule specifically for the “Pension and Annuity Subtraction” where you report the amount you are eligible to subtract.

After completing the DR 0104AD, the total subtractions from that schedule are carried over to the main Colorado Individual Income Tax Return, form DR 0104. This process ensures that your federally reported income is properly reduced by the allowable state-specific subtraction before your final Colorado tax liability is calculated.