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What Impact Will Reduction in Pension Exclusion Have?


Though it has been treated as if it was one of the Ten Commandments, Kentucky’s pension exclusion, which exempts pension income from state income taxes, has actually only been in place since 1995. In 1997, the exclusion amount was increased from $6,250, where it had been established two years earlier, to $35,000 and indexed to inflation. The indexing was frozen as part of the 2005 tax reform package at $41,110, providing us with the arbitrary figure that the exclusion remained at for the following 13 years.

A decrease in the pension exclusion has historically been supported by Democrats and Republicans alike with Democrats calling for the change for reasons of “fairness” and Republicans as a method of “base-broadening.” The Beshear tax commission proposed moving the exclusion to $30,000 with a phase out for those who had at least $80,000 in income. Governor Beshear’s tax commission predicted that this would only impact approximately 90,000 tax filers but generate over $175 million in revenue.

Kentucky’s 2018 Tax Reform package lowered the pension exclusion to $31,110, settling at a rate lower than the Beshear tax commission recommended but did not include the phase out. For that reason the projected revenue score is lower, but will still add much needed revenue and accomplish the goals of both parties of increased fairness and a broader income tax base.

Who Will it Impact?

If anything, the exclusion is actually still too high, as evidenced by most of our neighbors and comparable states in the region. Aside from Tennessee, which does not have income taxes at all, and Illinois, which fully excludes pension income from taxation, all of Kentucky’s neighboring states have a lower exemption, or no exemption at all.

More than 2/3rd of retirees in the Kentucky Retirement System, the system with the most pensioners (106,234), draw less than $20,000 and the average pension is $16,161. In fact, the average KRS pension is below $31,000 in 119 of Kentucky’s 120 counties. It is below $20,000 in 108 of Kentucky’s 120 counties. In nearly every county in Kentucky, the average person drawing a Kentucky Retirement System pension will remain unaffected by the pension exclusion being lowered to $31,110 and would remain unaffected even at a lower threshold.

The average pension for individuals in a private pension is an even lower number and will likewise be unaffected by the reduced threshold. According the Pension Rights Center, an advocacy group in their fifth decade of existence, the average private pension provides an annual payout of $9,262. Individuals who receive a private pension in addition to Social Security have an average income of $36,270. Because Social Security is not subject to tax in Kentucky, the average individual in this situation is likewise not subject to income tax.

For those with 401(k)s, the average person in their 60’s has approximately $150,000 in savings, which, according to Blackrock financial, would equal an annual payout of $7,587. This obviously falls well short of the new $31,110 exclusion threshold.

In all of these cases, the average retiree will not be impacted by the reduction in Kentucky’s pension exclusion, and most would not be impacted with an even lower exclusion.

Does the Exclusion Even Work?

One of the key questions is whether the exclusion serves its purpose in the first place. The argument for a pension exclusion was that it would allow us to retain more retirees, keeping them in Kentucky rather than moving to other states. In 1994, the year before the exclusion was added, 10.28% of pensioners in the Teacher Retirement System, the system with higher average incomes more likely to be impacted by the exclusion, lived outside of Kentucky. Last year, 11.39% of pensioners in the Teacher Retirement System lived outside of Kentucky. Not only has the exclusion failed to keep more pensioners in Kentucky, a higher percentage have actually left, even with the exclusion in place. Additionally, our current percentage of pensioners living outside the state (11.39%) is nearly the exact same as Indiana (11.3%), which provides virtually no income tax exemptions for retirees.

There is ample evidence to declare the pension exclusion is a policy failure and a credit which has not achieved its goals. Even aside from this, evidence suggests that the new threshold, which allows pensioners to take $31,110 in annual income without paying state taxes, will in most cases only impact retirees with above average pension income.

What is the Average Pension in Your County?

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