Pensions and Annuities

If you receive retirement benefits in the form of pension or annuity payments from a qualified employer retirement plan, the amounts you receive may be fully taxable, or partially taxable.

Social security and equivalent railroad retirement benefits are not discussed here. For more information about these benefits, refer to Tax Topic 423.

The pension or annuity payments that you receive are fully taxable if you have no cost in the contract because any of the following situations apply:

• You did not contribute anything or are not considered to have contributed anything for the pension or annuity
• Your employer did not withhold contributions from your salary, or
• You received all of your contributions (your basis) tax free in prior years

If you contributed after-tax dollars to your pension or annuity, your pension payments are partially taxable. You will not pay tax on the part of the payment that represents a return of the after-tax amount you paid. This amount is your cost in the plan or investment, and includes the amounts your employer contributed that were taxable to you when contributed. Partly taxable pensions are taxed under either the General Rule or the Simplified Method. For more information on the General Rule and Simplified Method refer to Tax Topic 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 payments are taxable and how much is tax free.

If you receive pension or annuity payments before age 59 1/2, you may be subject to an additional 10% tax on early distributions. The additional tax does not apply to any part of a distribution that is tax free. There are also general exceptions to the additional tax, including:

• Distributions made as a part of a series of substantially equal periodic payments from a qualified plan that begins after your separation from service
• Distributions made because you are totally and permanently disabled
• Distributions made on or after the death of the plan participant or contract holder, and
• Distributions made from a qualified retirement plan after your separation from service and in or after the year you reached age 55

For other exceptions to the tax, refer to Publication 575, Pension and Annuity Income.

If you are a survivor or beneficiary of a pension plan or annuity, refer to Publication 575 for rules on income and taxes.

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

You may choose not to have income tax withheld from your pension or annuity payments (unless they are eligible rollover distributions) or want to specify how 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. Withholding from periodic payments of a pension or annuity is generally figured the same way as for salaries and wages. If you do not submit the withholding certificate, the payer must withhold tax as if you were married and claiming three withholding allowances. If you do not provide the payer with your correct social security number, tax will be withheld as if you were single and claiming no withholding allowances.

If you pay your taxes through withholdings and not enough is withheld, you may also need to make estimated tax payments to ensure your taxes are not underpaid. For more information on increasing your withholdings, making estimated tax payments, and the consequences of not withholding the proper amount of tax, refer to Publication 505, Tax Withholding and Estimated Tax.

Special rules apply to certain non-periodic payments from qualified retirement plans. For information on the special tax treatment of lump-sum distributions, refer to Tax Topic 412. If an eligible rollover distribution is paid to you, the payer must withhold 20% of it, unless you choose the direct rollover option. For more information refer to Tax Topic 413.