Does Pennsylvania Tax Pensions? IRAs, Annuities, and Inheritance

Pennsylvania does not tax pensions in most cases. The state’s flat 3.07% personal income tax exempts distributions from employer pensions, 401(k)s, 403(b)s, and IRAs once specific conditions are met, and it unconditionally exempts Social Security, military retirement pay, and Railroad Retirement benefits.¹ The conditions are where people get caught, especially around early withdrawals and IRAs rolled over from workplace plans.

Employer Pensions, 401(k)s, and 403(b)s

Distributions from employer-sponsored retirement plans are exempt from Pennsylvania’s personal income tax when two conditions are satisfied. The plan has to be an eligible retirement plan under the Internal Revenue Code, which covers defined benefit pensions, 401(k)s, 403(b)s, profit-sharing plans, money purchase plans, and government thrift savings plans.² And the payments must be received after you have both separated from service and met the plan’s own age or years-of-service requirement for retirement.³

The plan’s governing documents set those thresholds. If your pension says you can retire at 55 with 30 years of service, that is the standard Pennsylvania uses. You do not have to wait until 59½ or any other federal benchmark.

The separation-from-service piece catches people off guard. If you hit your plan’s retirement age but keep working and start taking distributions, Pennsylvania treats those payments as taxable compensation. The exemption applies only after you actually leave the job.

Traditional and Roth IRAs

IRAs follow a different rule because they are not employer-sponsored. Pennsylvania treats an IRA distribution as exempt as long as the withdrawal would not trigger a federal early withdrawal penalty.² In practice, distributions after age 59½ are exempt, as are distributions due to death or disability. There is no separation-from-service requirement.

This is where the rules diverge in a way that costs people money. If you retire at 55 from a job with a 401(k) and roll the balance into a traditional IRA, withdrawals from that IRA before age 59½ become taxable in Pennsylvania even though the same money in the 401(k) might have been exempt. The rollover changed which exemption rule applies. Anyone weighing an early-retirement rollover should understand this before moving the funds.

Qualified Roth IRA distributions are also exempt. Since Roth contributions are made with after-tax dollars at both the federal and state level, qualified withdrawals come out tax-free. Roth 401(k) distributions follow the same logic.

Social Security, Military Pay, and Railroad Retirement

Three major retirement income sources are exempt from Pennsylvania’s personal income tax with no age, service, or plan-type conditions:

Social Security retirement and disability benefits are completely exempt. This is a meaningful advantage over states that tax Social Security above certain income thresholds.²
Military retirement pay is exempt regardless of the recipient’s age or length of service, for all branches of the uniformed services.⁴
Railroad Retirement benefits, both Tier 1 and Tier 2, are exempt.²

None of these require you to meet plan-specific retirement criteria or separate from service. If you receive the benefit, it is exempt.

Annuity Income

How Pennsylvania taxes an annuity depends on where it came from. An annuity purchased through an employer-sponsored retirement plan is exempt if it qualifies as a “qualified annuity,” meaning equal or substantially equal periodic payments made at least annually over your lifetime, your life expectancy, or a period of at least 10 years.²

Annuities you buy on your own outside any employer plan work differently. Pennsylvania taxes the earnings portion of privately purchased annuity payments as interest income to the extent the payments exceed your original investment. You report the gain on PA Schedule D using the cost-recovery method. This distinction surprises retirees who assume all annuity income is exempt because they bought the annuity for retirement.

When Retirement Distributions Do Become Taxable

The most common way retirement income becomes taxable in Pennsylvania is withdrawing it too early. For employer plans, that means taking money before you have both separated from service and met the plan’s retirement criteria. For IRAs, it means a withdrawal that would trigger a federal early withdrawal penalty.³

When a distribution is taxable, Pennsylvania uses the cost-recovery method. The state does not allow deductions for contributions to 401(k)s, IRAs, SEP plans, or other retirement accounts, so you paid Pennsylvania income tax on that money the year you earned it.⁵ Under cost recovery, you recover those previously taxed contributions first before any earnings become taxable. Only the earnings portion of an early withdrawal is subject to the 3.07% tax.³ For someone who contributed heavily over a long career, a significant share of an early distribution may be a nontaxable return of contributions.

Nonqualified Deferred Compensation

Nonqualified deferred compensation plans do not get the same favorable treatment as qualified pensions and 401(k)s. Distributions tied to elective deferrals are taxable as compensation when paid out, regardless of whether you are retired at the time.⁶ If you can document that specific elective deferrals were previously taxed by Pennsylvania during certain transition years, those amounts can be excluded through cost recovery, with substantiation.⁷ Amounts that must be included in federal gross income under IRC Section 409A are also deemed received as compensation for Pennsylvania purposes, even if no money was actually distributed.

Local Earned Income Taxes

Pennsylvania municipalities levy their own earned income taxes. Retirement income that is exempt from the state personal income tax is also exempt from local earned income taxes.⁸ You will not owe local income tax on your pension, 401(k), IRA, or Social Security payments.

Inheritance Tax on Retirement Accounts

Pennsylvania’s generosity on income tax does not extend to inheritance tax. Retirement accounts are generally subject to Pennsylvania inheritance tax when they pass to beneficiaries after death. The rate depends on the beneficiary’s relationship to the deceased:⁹

Surviving spouse: 0%
Direct descendants, including children and grandchildren: 4.5%
Siblings: 12%
All other heirs: 15%

A parent inheriting from a child aged 21 or younger also pays 0%. Transfers to charitable organizations and government entities are exempt. The inheritance tax return is due nine months after the date of death, and estates that pay within three months receive a 5% discount.⁹

A $500,000 IRA passing to an adult child would generate roughly $22,500 in Pennsylvania inheritance tax at the 4.5% rate, on top of whatever federal income tax the child owes on distributions. Naming a spouse as beneficiary avoids the inheritance tax entirely. For non-spouse beneficiaries, the interaction between inheritance tax and federal income tax on distributions makes retirement account beneficiary designations one of the more consequential estate planning decisions in the state.

1
Commonwealth of Pennsylvania. Tax Rates
2
PA.gov. PA Personal Income Tax Guide – Gross Compensation
3
Commonwealth of Pennsylvania. Gross Compensation
4
The Official Army Benefits Website. Pennsylvania Military and Veteran Benefits
5
Pennsylvania Department of Revenue. PA Personal Income Tax Guide – Deductions and Credits
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Pennsylvania Department of Revenue. Personal Income Tax Bulletin 2005-03 – Deferred Compensation Under Nonqualified Plans
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Pennsylvania Department of Revenue. Pennsylvania Personal Income Tax No. PIT-06-009 – Distributions from Nonqualified Deferred Compensation Plan
8
Pennsylvania Municipal Retirement System. Taxes
9
Department of Revenue | Commonwealth of Pennsylvania. Inheritance Tax