If you have your savings in a typical retirement account, such as an IRA or a 401(k), you can benefit from the deferral of taxes on any income you earn within the accounts. Unfortunately, the deferral is not infinite, and you must pay taxes when you take money out of these types of accounts. In Kentucky, you may be able to shield some of your pension income from state taxes by filing the appropriate form.
Regular Income Tax
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While not strictly a "penalty," taking money out of a retirement plan in Kentucky does have financial consequences in the form of taxes. The IRS regards nearly all pension distributions as taxable income, so you must include the amount of your Kentucky retirement withdrawal in your gross income when you file your taxes. As Kentucky is one of the states that impose a state income tax, as a Kentucky resident you must include the amount of your pension distribution in your state income as well. As of 2011, Kentucky does exempt pension distributions above $41,110 from state tax if you are retired from government service and you receive railroad retirement benefits. You must file Schedule P of Form 740 with your Kentucky state tax return to exempt this pension income.
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Early Distribution Penalties
As retirement money is meant to grow for your retirement, the IRS penalizes you for taking your retirement money before you reach age 59 1/2. In addition to federal and Kentucky state tax, you will owe an additional 10 percent of the amount you withdraw if you take it out too early. Kentucky does not levy an additional early distribution penalty, as some states do, but it has the right to change its tax legislation in the future if it desires.
Insufficient Withdrawal Penalties
The benefits of tax deferral in a retirement account can be so great that you may want to keep your money invested in an IRA or other pension account as long as you can. Unfortunately, there is an IRS-imposed time limit on how long you can wait before you have to begin taking at least something out of your retirement accounts. Known as required minimum distributions, these annual payments must come out of your retirement accounts once you reach age 70 1/2, otherwise you can face substantial penalties. While the state of Kentucky does not assess additional penalties should you fail to take out the minimum required amount, the IRS does levy a 50-percent penalty on the amount designated for withdrawal.
Loss of Future Growth
With any investment account, the more you withdraw, the less you have invested for future growth. Every distribution you take from your retirement account in Kentucky penalizes your future by reducing the amount of your invested assets. The more you take out, the less you will have for your future needs.