Kentucky State Tax on 401k Withdrawals: Exclusion, Penalties, and Filing

Kentucky taxes 401k withdrawals at the state’s flat individual income tax rate of 3.5% for 2026, but a retirement income exclusion shelters the first $31,110 per person from state tax.¹ A retiree who pulls $31,110 or less from a 401k in a given year owes no Kentucky tax on the distribution. Only the amount above that threshold is taxed, and it’s taxed at a single flat rate, so the math is straightforward.

How the $31,110 Retirement Income Exclusion Works

The exclusion is where Kentucky delivers most of the tax break for retirees. You can exclude up to $31,110 per person in qualifying retirement income for the 2026 tax year.² Qualifying income includes distributions from 401k plans, traditional IRAs, pensions, annuity contracts, profit-sharing plans, and disability retirement benefits.³ A traditional-to-Roth IRA conversion also counts toward the exclusion.

The $31,110 cap applies to the total of all qualifying retirement income you receive during the year, not to each account separately. If you take $20,000 from a 401k and $15,000 from a traditional IRA, your combined $35,000 leaves $31,110 excluded and $3,890 taxable at the state level.

A married couple filing jointly can exclude up to $62,220 combined, but only when each spouse has their own qualifying retirement income. The exclusion is calculated per taxpayer and is not transferable. If one spouse receives $50,000 in 401k distributions and the other receives nothing, only $31,110 is excluded, not $62,220.²

There are no income phase-outs. Whether your total income is $40,000 or $400,000, the full $31,110 exclusion is available. Social Security benefits are separately exempt from Kentucky income tax and do not count against the $31,110 cap.³

A Worked Example

You withdraw $50,000 from your 401k in 2026 and have no other retirement income. The first $31,110 is excluded. The remaining $18,890 is taxable at 3.5%, giving you a Kentucky tax bill of roughly $661. Without the exclusion, you’d owe $1,750 on the full $50,000. The exclusion saves you about $1,089.

Roth 401k Distributions

Qualified Roth 401k distributions are tax-free at the federal level and never enter your federal adjusted gross income. Because Kentucky starts from federal AGI, qualified Roth distributions are not taxed by Kentucky either. They don’t count toward or use up your $31,110 exclusion, since they aren’t taxable retirement income in the first place.

A non-qualified Roth 401k distribution is different. If you haven’t met the five-year holding period or age requirements, the earnings portion is included in federal AGI and flows through to your Kentucky return. That taxable portion qualifies for the retirement income exclusion just like a traditional 401k withdrawal.⁴

Early Withdrawals Before Age 59½

Kentucky does not impose its own penalty on early 401k withdrawals. The federal government does. A 10% additional tax applies to most 401k distributions taken before age 59½, on top of regular income tax, and it’s reported on federal Form 5329.⁵ It doesn’t appear on your Kentucky return.

The full distribution still lands in your federal AGI and passes through to Kentucky, where the $31,110 exclusion applies as usual. You won’t pay a state penalty, but you’ll still owe Kentucky’s 3.5% on anything above the exclusion, plus the 10% federal penalty and regular federal income tax. Early withdrawals get expensive when those three layers stack.

Several federal exceptions can eliminate the 10% penalty, including separation from service after age 55, certain disability situations, and substantially equal periodic payments. These affect only the federal penalty. Kentucky’s treatment of the distribution doesn’t change.

State Withholding and Estimated Payments

Kentucky does not require plan administrators to withhold state income tax from retirement distributions.⁶ That’s the opposite of the federal rule, which requires 20% withholding on most rollover-eligible lump-sum payouts. Unless you tell your plan administrator to withhold Kentucky tax, nothing comes out for the state.

You can ask for voluntary withholding at 3.5% or specify a dollar amount or percentage. This is worth doing when your distribution will clearly exceed $31,110. Without withholding, you owe the whole state tax bill at filing time, and that surprise stings if the money has already been spent.

If you skip withholding and your expected Kentucky tax liability after credits exceeds $500, you have to make quarterly estimated payments on Kentucky Form 740-ES.⁷ Missing them can trigger interest and an underpayment penalty on Form 2210-K. For a one-time large withdrawal, electing withholding upfront is almost always simpler than trying to catch up with estimated payments.

Filing the Withdrawal on Your Kentucky Return

Kentucky residents report 401k distributions on Form 740. Your plan administrator issues a federal Form 1099-R showing the amount, and that figure carries over to your Kentucky return as part of federal adjusted gross income.³

To claim the retirement income exclusion, complete Kentucky Schedule P, the Pension Income Exclusion form. Schedule P lists your qualifying retirement income, applies the $31,110 cap, and produces the exclusion amount that gets subtracted on Form 740.³ Skipping this form means forfeiting the exclusion entirely.

If you elected voluntary withholding, report it on Schedule KW-2 and attach that to Form 740. Kentucky won’t credit the withholding without the schedule enclosed.³ Keep your 1099-R and any W-2s with your records; they don’t get filed with the return, but you have to produce them if the state asks.

If You Moved In, Out, or Away From Kentucky

If you moved into or out of Kentucky during the year, file Form 740-NP and report only the retirement income received while you were a Kentucky resident. The $31,110 exclusion is available for that resident-period income, calculated on Schedule P the same way a full-year resident would.⁸

If you no longer live in Kentucky at all, federal law protects the distribution. Under 4 U.S.C. § 114, no state may tax the retirement income of a nonresident, regardless of where the account was earned or where the employer was located.⁹ That protection covers 401k plans, IRAs, 403(b) plans, 457 plans, and government pensions. Work 30 years in Kentucky, retire to Florida, take a 401k distribution, and Kentucky cannot tax it. Your new state of residence sets any state tax that applies.

A Possible Change for 2027

Kentucky House Bill 183, introduced in the 2026 legislative session, proposes raising the retirement income exclusion from $31,110 to $41,110 for tax years beginning January 1, 2027.¹⁰ As of early 2026, the bill had been referred to the House Appropriations and Revenue Committee and had not passed. If it becomes law, the tax-free threshold would rise for the 2027 tax year. For 2026 returns, the $31,110 limit applies.

The 3.5% flat rate itself has been trending down through a statutory trigger tied to state budget conditions. It was 4.0% as recently as 2024, so older guides may quote a higher number than what actually applies to a 2026 withdrawal.¹¹

1
Kentucky Department of Revenue. 2026 Kentucky Withholding Tax Formula
2
Kentucky Legislative Research Commission. Kentucky Revised Statutes KRS 141.019 – Calculation of Adjusted Gross Income and Net Income
3
Kentucky Department of Revenue. 2025 Kentucky Individual Income Tax Instructions for Form 740
4
Department of Revenue. Schedule M – Modifications to Federal Adjusted Gross Income Form 740 (2025) Instructions
5
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
6
Teachers’ Retirement System of the State of Kentucky. Kentucky Resident State Tax Withholding Certificate
7
Kentucky Department of Revenue. Instructions for Filing Estimated Tax Vouchers
8
Kentucky Department of Revenue. Schedule P (2025) – Pension Income Exclusion
9
Office of the Law Revision Counsel. 4 USC 114 – Limitation on State Income Taxation of Certain Pension Income
10
Kentucky Legislative Research Commission. 26RS House Bill 183
11
Kentucky Legislative Research Commission. Kentucky Revised Statutes KRS 141.020 – Reduction, Tax Credits, Income of Nonresidents Subject