Are 401(k) Distributions Taxable in Pennsylvania?

by Cam Merritt

Pennsylvania generally does not charge income tax on distributions from a 401(k) plan, as long as you receive those distributions after age 59 1/2. This makes Pennsylvania different from the federal government and most other states, which tax all 401(k) distributions. However, that doesn't mean 401(k) accounts in Pennsylvania go untaxed.

401(k) Plans

An employer-sponsored 401(k) plan allows you to save money for retirement by diverting some of your wages into an investment account. You pay no income tax on any profits made from investments in the 401(k). Then, once you reach age 59 1/2, you can start withdrawing money from the account. In the language of the plans, the money you put into the account is your "contribution;" the money you take out is a "distribution." In the federal tax system -- and most state income tax systems -- you don't pay income taxes on your 401(k) contributions. All taxes are deferred, for years and often decades, until you take a distribution. Even then, you pay tax only on the money you actually take out, regardless of how much you put in, how much you've profited from your investments or how much money is in the account. But that's not how Pennsylvania does it.

Pennsylvania's System

Pennsylvania's tax treatment of 401(k) plans is essentially the opposite from the federal system's. In Pennsylvania, your 401(k) contributions are fully taxable in the year you make them. Investment profits are still tax-free. Then, when you reach the eligible age of 59 1/2, your distributions are completely untaxed.

Early Distributions

If you make a withdrawal from your 401(k) plan before turning 59 1/2, however, then that money might be subject to Pennsylvania income tax. Pennsylvania taxes early distributions on a "cost recovery basis." That means you don't pay taxes until your total distributions exceed your total contributions. Suppose you've contributed a total of $10,000 to your 401(k), and your account has grown to $30,000. If you were to take money out before age 59 1/2, you wouldn't pay Pennsylvania tax on the first $10,000. That's the money you put in -- it's "your money" -- and it has already been taxed. But everything above $10,000 will be taxed. Under the federal system, by contrast, early distributions are not only fully taxable, they're also subject to a 10 percent penalty, though the penalty can be waived in certain "emergency" or "hardship" situations.

Reporting a Taxable Distribution

Anyone who receives a distribution from a 401(k) should get a copy of Form 1099-R at the end of the year. Plan administrators use this form to report how much you received in distributions. The total amount of the distribution appears in Box 1. If it's an early distribution, subject to Pennsylvania tax, Box 7 of the form will have a distribution code of either "1" or "2." Your plan administrator should be able to tell you whether your distributions have exceeded your contributions and, if so, by how much. Include the taxable amount on Line 1a of Form PA-40, the Pennsylvania personal income-tax return.

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