2.6- Pensions and Annuities

If you receive retirement benefits in the form of pension or annuity payments from a qualified employer retirement plan, all or some portion of the amounts you receive may be taxable unless the payment is a qualified distribution from a designated Roth account.

This topic doesn't cover the taxation of social security and equivalent railroad retirement benefits. For information about tax on those benefits, refer to Topic No. 423 and Are My Social Security or Railroad Retirement Tier I Benefits Taxable?

Fully Taxable Payments

The pension or annuity payments that you receive are fully taxable if you have no investment in the contract (sometimes referred to as "cost" or "basis") due to any of the following situations:

• You didn't contribute any after-tax amounts or aren't considered to have contributed any after-tax amounts for your pension or annuity

• Your employer didn't withhold after-tax contributions from your salary, or

• You received all of your after-tax contributions (your investment in the contract) tax-free in prior years

Partially Taxable Payments

If you contributed after-tax dollars to your pension or annuity, your pension payments are partially taxable. You won't pay tax on the part of the payment that represents a return of the after-tax amount you paid. This amount is your investment in the contract and includes the amounts your employer contributed that were taxable to you when contributed. Taxpayers figure the tax on partly taxable pensions by using either the General Rule or the Simplified Method. For more information on the General Rule and Simplified Method, refer to Topic No. 411. If the starting date of your pension or annuity payments is after November 18, 1996, you generally must use the Simplified Method to determine how much of your annuity payment is taxable and how much is tax-free.

Additional 10% Tax on Early Distributions

If you receive pension or annuity payments before age 59½, you may be subject to an additional 10% tax on early distributions, unless the distribution qualifies for an exception. The additional tax generally doesn't apply to any part of a distribution that's tax-free or to any of the following types of distributions:

• Distributions made as a part of a series of substantially equal periodic payments that begins after your separation from service.

• Distributions made because you're totally and permanently disabled.

• Distributions made on or after the death of the plan participant or contract holder.

• Distributions made after your separation from service and in or after the year you reached age 55.

• Distributions up to $5,000 made within a year of the birth or adoption of your child to cover birth or adoption expenses.

For other exceptions to the additional 10% tax, refer to Publication 575, Pension and Annuity Income and Instructions for Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.

Survivor or Beneficiary

If you're a survivor or beneficiary of a pension plan participant or annuitant, refer to Publication 575 for rules relating to income inclusion.

Tax Withholding

The taxable part of your pension or annuity payments is generally subject to federal income tax withholding.

You may be able to choose not to have income tax withheld from your pension or annuity payments (unless they're eligible rollover distributions) or may want to specify how much tax is withheld. If so, provide the payer Form W-4P, Withholding Certificate for Pension or Annuity Payments or a similar form provided by the payer along with your social security number (SSN). If you're a U.S. citizen or resident alien, you must provide the payer with a home address in the United States (or its possessions) to be able to choose to have no tax withheld. Payers generally figure the withholding from periodic payments of a pension or annuity the same way as for wages. If you don't submit the Form W-4P withholding certificate, you don’t provide your SSN, or the IRS notifies the payer that you gave an incorrect SSN, then the payer must withhold tax as if your filing status is single with no adjustments in Steps 2 through 4.

Special rules apply to certain nonperiodic payments from qualified retirement plans. For information on the special tax treatment of lump-sum distributions, refer to Topic No. 412. If you receive an eligible rollover distribution, the payer must withhold 20% of the taxable amount of it, even if you intend to roll it over later. You can avoid this withholding by choosing the direct rollover option. A distribution sent to you in the form of a check payable to the receiving plan or IRA isn't subject to withholding. For more information on rollovers, refer to Topic No. 413 and visit Do I Need to Report the Transfer or Rollover of an IRA or Retirement Plan on My Tax Return?

Estimated Tax Payments

If you pay your taxes through withholding and the withheld tax isn't enough, you may also need to make estimated tax payments to ensure you don't underpay taxes during the tax year. For more information on increasing withholding tax, making estimated tax payments, and the consequences of not withholding the proper amount of tax, refer to Publication 505, Tax Withholding and Estimated Tax.

Additional Information

For more information, refer to Publication 575 and Is My Pension or Annuity Payment Taxable?