Does Kentucky Tax IRA Distributions?

Understanding how states tax retirement income, such as distributions from Individual Retirement Accounts (IRAs), is important for financial planning. While the federal government has its own rules for taxing IRA withdrawals, each state establishes its unique income tax laws. This article will explain how Kentucky specifically taxes distributions from your IRA, helping you navigate the state’s tax landscape.

General Taxation of IRA Distributions in Kentucky

Kentucky considers distributions from Individual Retirement Accounts (IRAs) as taxable income, similar to how they are treated at the federal level. The state’s income tax system uses your federal adjusted gross income (AGI) as a starting point for calculating your state tax liability. If an IRA distribution is subject to federal income tax, it will be included in your income for Kentucky state tax purposes as well.

For traditional IRAs, Simplified Employee Pension (SEP) IRAs, and Savings Incentive Match Plan for Employees (SIMPLE) IRAs, distributions are taxable by Kentucky to the same extent they are taxable federally. This means that pre-tax contributions and earnings, when withdrawn, are subject to Kentucky’s income tax. Qualified distributions from Roth IRAs are tax-free at both federal and state levels. Only non-qualified Roth IRA distributions, which primarily involve withdrawals of earnings made before certain conditions are met, are subject to Kentucky tax if federally taxable.

Kentucky’s Pension and Retirement Income Exclusion

Kentucky provides a tax benefit through its pension and retirement income exclusion, which can reduce or eliminate the state tax on eligible retirement distributions, including those from IRAs. For the 2024 and 2025 tax years, individuals can exclude up to $31,110 of qualified retirement income per person from their taxable income. This exclusion applies broadly to various types of retirement income, encompassing distributions from IRAs, pensions, and 401(k) plans.

This exclusion functions as a subtraction from your total income, directly lowering the amount of retirement income subject to Kentucky’s state income tax. It is not a tax credit that directly reduces your tax bill, but rather a deduction that decreases your taxable income. For instance, if your total annual IRA distributions amount to $30,000, and no other retirement income is received, the entire distribution would fall within the $31,110 exclusion limit and would not be subject to Kentucky state income tax. If your combined retirement income exceeds this threshold, only the amount above $31,110 would be considered taxable by the state.

A legislative change is planned to increase this exclusion. For taxable years beginning on or after January 1, 2026, the maximum exclusion amount for pension and retirement income is set to increase to $41,110. This adjustment will allow taxpayers to shield a larger portion of their retirement distributions from state income tax in future years.

Reporting IRA Distributions on Your Kentucky Tax Return

After accounting for federal adjustments and applying Kentucky’s pension and retirement income exclusion, the remaining taxable portion of your IRA distributions is integrated into your overall Kentucky state income tax calculation. This amount contributes to your total taxable income reported to the state. Residents of Kentucky report their income and calculate their state tax liability using Form 740, the Kentucky Individual Income Tax Return.

Taxable IRA distributions are added to other sources of income subject to Kentucky’s income tax. Kentucky applies a flat income tax rate of 4% to taxable income for the 2024 and 2025 tax years. The state’s tax rate is scheduled to decrease to 3.5% starting in January 2026.

The inclusion of taxable IRA distributions in your total income directly influences your overall state tax liability. Understanding the exclusion and accurately reporting your distributions ensures proper compliance with Kentucky’s tax laws.