Identification

• Retirement accounts, such as 401k, traditional IRA and Roth IRA plans all provide for tax deferral. Tax deferral means that you will not owe any federal or state taxes on capital gains and investment income as they accrue within the retirement account. At the federal level, 401k and traditional IRA contributions are tax-deductible items. Upon withdrawal, 401k and traditional IRA distributions are taxed as ordinary income on your federal taxes. Roth IRA contributions are made with after-tax money at the federal level, which generally allows for tax-free withdrawals to the IRS. In Pennsylvania, however, 401k and IRA contributions are not tax deductible. Consequently, you do not pay income tax on any 401k or IRA distributions taken after age 59 1/2.
  
  

Retirement Account Early Withdrawals

• Early retirement account withdrawals are made before age 59 ½. Early retirement account withdrawals that exceed your initial contributions are generally treated as taxable income in Pennsylvania. During the 2010 tax year, all Pennsylvania taxable income is taxed at a 3.07 percent flat rate. For example, you may have put $5,000 into a traditional IRA to buy mutual funds as a young professional. At age 45, the account grows to $15,000 before you take a withdrawal. You would then treat $10,000 worth of retirement account distributions as Pennsylvania taxable income, which would effectively increase your Pennsylvania state tax bill by $307.
  
  

Additional Tax Penalty

• On your federal taxes, you would generally owe a 10 percent additional tax penalty on early withdrawals. For your Pennsylvania income taxes, however, no additional tax penalty applies to early retirement withdrawals. The federal additional tax penalty would come in addition to the federal ordinary income taxes that were triggered by the distribution. At the federal level, ordinary income is taxed at 10, 15, 25, 28, 33 and 35 percent rates.
  
  

Exemptions and Qualified Distributions

• Early retirement account distributions may be exempt from the federal additional tax penalty if the withdrawals were made to provide for a first-time home purchase, college tuition payments or medical bills above 7.5 percent of your adjustable gross income. As Pennsylvania does not tax qualified distributions, these would not be considered income in Pennsylvania. You will also be exempt from both the federal additional tax penalty and Pennsylvania state taxes if the withdrawals were made due to disability. Be advised that the IRS and State of Pennsylvania define disability as a condition that makes it impossible for you to work any profession.