How Much Does Indiana Tax Your Pension?

Indiana taxes various types of income, including pensions, though specific rules and potential deductions can influence the actual amount owed. Understanding the state’s tax framework for retirement income is important for individuals planning their financial future or managing their current retirement funds.

Indiana State Income Tax Basics

Indiana implements a flat state income tax rate. For the 2024 tax year, this rate is 3.05%, with plans for gradual reductions in subsequent years. This flat rate contrasts with federal income tax, which uses a progressive system with varying rates based on income levels.

The starting point for calculating Indiana’s state income tax is an individual’s federal adjusted gross income (AGI). From this federal AGI, Indiana applies its own set of additions and subtractions to arrive at the state’s adjusted gross income, which then becomes the base for the state tax calculation. Various types of income earned by residents, including wages, interest, dividends, and retirement income, are generally included in this tax base.

State Taxability of Pension Income

As a general rule, most pension and annuity income received by Indiana residents is subject to the state’s flat income tax. This includes distributions from various retirement accounts such as 401(k)s and IRAs.

This state tax treatment is distinct from federal income tax rules, although Indiana often uses federal AGI as a starting point. While Social Security benefits are exempt from Indiana state income tax, other forms of retirement income, including most private and public pensions, generally remain taxable. This means that if a pension distribution is included in federal AGI, it will typically be included in Indiana’s tax base unless a specific state deduction or exemption applies.

Available Deductions and Exemptions for Pension Income

Indiana offers deductions that reduce taxable pension income. One significant deduction is the Indiana Retirement Income Deduction, which can apply to certain types of retirement income. Individuals receiving a federal civil service annuity may be eligible for a deduction of up to $16,000.

To qualify for this civil service annuity deduction, the taxpayer must be at least 62 years of age by the end of the taxable year, or be a surviving spouse of the annuitant, regardless of age. The deductible amount is, however, reduced by any Social Security benefits or railroad retirement benefits received during the same taxable year. Another important exemption applies to military retirement income, which is fully exempt from Indiana state income tax as of the 2022 tax year.

Beyond these, individuals who retired due to permanent and total disability may qualify for a disability retirement deduction. This deduction is limited to a maximum of $5,200 per eligible individual. These deductions and exemptions directly reduce the taxable portion of pension income, thereby lowering an individual’s overall state tax liability.

County Income Taxes Affecting Pensions

In addition to the state income tax, Indiana counties also have the authority to impose their own income taxes. All 92 counties in Indiana levy a local income tax, with rates varying significantly across different counties. These rates can range from approximately 0.5% up to 3% or more, depending on the specific county.

County income taxes are generally applied to the same income base used for state income tax calculations, which includes pension income. An individual’s county tax liability is typically determined by their county of residence on January 1 of the tax year. This means that where a person lives at the beginning of the year dictates which county’s tax rate applies to their income, including their pension.