Kentucky does tax pensions, but most retirees owe far less than they expect. The state applies a flat 3.5% income tax rate for 2026, and each person can exclude the first $31,110 of qualifying retirement income — including pensions, 401(k) withdrawals, IRA distributions, and annuities — before any state tax applies.1Kentucky Legislative Research Commission. Kentucky Revised Statutes 141.0192Department of Revenue. 2026 Kentucky Withholding Tax Formula Social Security benefits, Railroad Retirement benefits, and VA disability compensation are fully exempt on top of that cap, and certain government and military pensions get even better treatment.
The $31,110 Pension Income Exclusion
The single most valuable tax break for Kentucky retirees is the pension income exclusion. You can subtract up to $31,110 per person from your state taxable income for qualifying retirement distributions.1Kentucky Legislative Research Commission. Kentucky Revised Statutes 141.019 On a joint return where both spouses receive qualifying income, each claims their own exclusion, sheltering up to $62,220 combined.3Kentucky Department of Revenue. Schedule P (2025)
Qualifying income covers distributions from essentially any written retirement plan: traditional pensions, 401(k)s, 403(b)s, profit-sharing plans, annuity contracts, IRAs, and deferred compensation arrangements. Lump-sum distributions count the same as periodic payments.1Kentucky Legislative Research Commission. Kentucky Revised Statutes 141.019
If your total qualifying retirement income falls below $31,110, the entire amount is state-tax-free. Only the portion above $31,110 reaches the 3.5% rate. A retiree receiving $45,000 in pension income, for example, would pay Kentucky tax on just $13,890, which works out to roughly $486.
Each spouse computes the exclusion separately on a joint return, and unused exclusion cannot transfer between spouses. If one spouse has $20,000 in qualifying income and the other has $40,000, the first excludes $20,000 and the second excludes $31,110, leaving $8,890 taxable.
Roth IRA distributions typically never enter this calculation because qualified Roth withdrawals aren’t included in federal adjusted gross income, which is Kentucky’s starting point.
The Flat 3.5% Rate on What’s Left
Kentucky begins with your federal adjusted gross income and applies state-specific adjustments.1Kentucky Legislative Research Commission. Kentucky Revised Statutes 141.019 Any pension or retirement distribution on your federal return also shows up on your Kentucky return before exclusions.
For tax year 2026, the flat rate is 3.5%, down from 4%.2Department of Revenue. 2026 Kentucky Withholding Tax Formula The rate applies to taxable income after the standard deduction ($3,360 for 2026) and any exclusions.4Department of Revenue. Kentucky DOR Announces 2026 Standard Deduction You can itemize instead if your deductions exceed the standard amount. Kentucky also offers a $40 personal tax credit if you’re 65 or older.
Retirement Income Kentucky Doesn’t Tax at All
Several categories of retirement income are fully exempt with no dollar cap, and they don’t eat into your $31,110 exclusion.
- Social Security benefits. Kentucky excludes all Social Security benefits that are taxable federally. The subtraction happens on your state return automatically.1Kentucky Legislative Research Commission. Kentucky Revised Statutes 141.019
- Railroad Retirement benefits. Both Tier 1 and supplemental Tier 2 benefits are fully exempt.3Kentucky Department of Revenue. Schedule P (2025)
- VA disability compensation. Veterans’ disability payments aren’t included in federal gross income, so they never appear on your Kentucky return.
Kentucky exempts Social Security entirely, but the federal government may still tax up to 85% of your benefits if your combined income (adjusted gross income plus tax-exempt interest plus half your Social Security) exceeds $25,000 for single filers or $32,000 for joint filers.5Social Security Administration. Must I Pay Taxes on Social Security Benefits? Many Kentucky retirees owe nothing to the state on Social Security but still owe federal tax on part of it.
Government and Military Pensions: The 1998 Cutoff
If you retired from federal, Kentucky state, or Kentucky local government service, or from the military, your pension may qualify for better treatment than the standard $31,110 exclusion depending on when you earned your service credit.
Kentucky State and Local Government Pensions
Benefits from the Kentucky Employees Retirement System (KERS), County Employees Retirement System (CERS), or Kentucky Teachers’ Retirement System (KTRS) split along a January 1, 1998 dividing line. The portion of your pension attributable to service earned before that date is completely exempt from Kentucky income tax with no cap.6Kentucky Public Pensions Authority. Taxes and Your Responsibilities The portion tied to service after that date is taxable but eligible for the $31,110 exclusion.7Teachers’ Retirement System Kentucky. Tax Information
Here’s how the math plays out. Say you worked for the state from 1989 through 2016, 27 years total. Nine of those years (1989 through 1997) fall before the cutoff, so the pension income tied to that period is fully exempt. The remaining 18 years of service credit fall after the cutoff, so that portion runs through the $31,110 exclusion. On an annual pension of $36,000, roughly one-third ($12,000) is exempt outright, and the remaining $24,000 fits inside the exclusion, so you’d owe no Kentucky tax on the pension at all.6Kentucky Public Pensions Authority. Taxes and Your Responsibilities
The same January 1, 1998 rule applies to federal government pensions received by Kentucky residents. Retirement credit for unused sick leave counts as earned at the time of retirement, not when the sick leave originally accrued.
Military Retirement Pay
If you retired from the U.S. Armed Forces before January 1, 1998, your entire military pension is exempt from Kentucky income tax.8U.S. Army Benefits. Kentucky State Military and Veterans Benefit Highlights and Eligibility If you retired after that date, your military pension is treated like any other qualifying retirement income and runs through the $31,110 exclusion.9Department of Revenue. Military Exemptions
Service members with creditable service before January 1, 1998 who actually retired later may be able to exclude more than $31,110, because the pre-1998 service portion is fully exempt in addition to the standard exclusion on the post-1997 portion. The Kentucky Department of Revenue publishes a calculator to help determine your exempt percentage.10Department of Revenue. Individual Income Tax
How to Claim the Exclusion on Your Return
Kentucky uses two schedules alongside Form 740 to handle retirement income adjustments.
Schedule P (Kentucky Pension Income Exclusion) is where the calculation happens. You need it if you receive government pension income with pre-1998 service credit, or if your total qualifying retirement income exceeds $31,110 and you need to separate the exempt portion from the taxable portion. Schedule P walks you through the pre-1998 exempt amount in Part I and the $31,110 exclusion on remaining retirement income in Part III, then combines them into a single figure.3Kentucky Department of Revenue. Schedule P (2025)
If your total qualifying retirement income is $31,110 or less and you have no pre-1998 government service, Schedule P isn’t required. Your entire retirement income qualifies for exclusion, and you report the subtraction on Schedule M.3Kentucky Department of Revenue. Schedule P (2025)
Schedule M (Adjusted Gross Income Modifications) collects all state adjustments to federal AGI. Fully exempt income like Social Security and Railroad Retirement benefits gets subtracted there, along with the final exclusion amount calculated on Schedule P. The total from Schedule M flows to Form 740 and reduces your Kentucky taxable income.10Department of Revenue. Individual Income Tax
Withholding and Estimated Tax Payments
Most pension and annuity payers withhold federal income tax automatically unless you opt out. If you receive multiple pensions, file a separate Form W-4P with each payer to control your federal withholding. Too little withholding during the year can trigger an underpayment penalty at tax time.11IRS. 2026 Form W-4P
Kentucky has its own estimated tax requirement. If you expect to owe $500 or more in state tax after subtracting withholding and credits, you generally need to make quarterly estimated payments. The due dates track the federal April 15, June 15, September 15, and January 15 schedule. Missing a payment triggers a penalty under KRS 131.183.
This trips up retirees whose pension income substantially exceeds the $31,110 exclusion and who haven’t arranged Kentucky withholding through their plan administrator. If you’re not sure your withholding is enough, the IRS tax withholding estimator at irs.gov/W4App can help calibrate the federal side.
One Thing to Watch: Kentucky’s Inheritance Tax
Kentucky’s income tax treatment of pensions is generous, but the state also imposes an inheritance tax, and retirement accounts are not exempt from it. When a Kentucky resident dies with money in an IRA, 401(k), or pension, the beneficiary who receives that money may owe Kentucky inheritance tax depending on their relationship to the deceased.
Close family members (spouses, parents, children, grandchildren, and siblings) are Class A beneficiaries and owe nothing. A retirement account left to a niece, nephew, son-in-law, daughter-in-law, aunt, or uncle (Class B) is taxed starting at 4% and climbing to 16% on amounts over $200,000. Friends, cousins, and other non-relatives (Class C) face rates from 6% to 16%, with the top rate kicking in at $60,000.12Kentucky Legislative Research Commission. Kentucky Revised Statutes 140.070 – Inheritance Tax Rates The exemption amounts are small: $1,000 for Class B and $500 for Class C. Naming a Class A beneficiary or a qualifying charity avoids the tax.