Taxation of Pension and Annuity Payments
Fully Taxable Payments
Your pension or annuity payments are fully taxable if you have no investment in the contract (also called "cost" or "basis"). This applies if:
You didn’t contribute any after-tax amounts to the plan.
Your employer didn’t withhold after-tax contributions from your salary.
You previously received all after-tax contributions tax-free in prior years.
Partially Taxable Payments
If you made after-tax contributions, your pension payments are partially taxable. You won’t pay tax on the portion of the payment that represents a return of your after-tax contributions. This amount includes employer contributions that were taxable to you when contributed.
To determine taxable and non-taxable portions, taxpayers must use either:
The General Rule
The Simplified Method (mandatory if the start date of payments is after November 18, 1996)
For details on these methods, refer to Topic No. 411.
Early Distributions and the Additional 10% Tax
If you receive payments before age 59½, you may be subject to a 10% additional tax, unless an exception applies. Exempt distributions include:
Substantially equal periodic payments after separation from service.
Distributions due to total and permanent disability.
Payments made to terminally ill individuals.
Distributions after the death of the plan participant.
For additional exceptions, see Publication 575 or Form 5329 Instructions.
Survivor or Beneficiary Rules
If you inherit a pension or annuity, special tax rules may apply. Refer to Publication 575 for guidance on income inclusion for survivors or beneficiaries.
Tax Withholding on Pensions and Annuities
The taxable portion of pension or annuity payments is subject to federal income tax withholding.
You can adjust withholding or opt out by submitting Form W-4P to the payer.
U.S. citizens and resident aliens must provide a U.S. address to opt out of withholding.
If no Form W-4P is submitted, the payer must withhold tax as if you are single with no adjustments.
Special withholding rules apply for:
Lump-sum distributions (see Topic No. 412).
Eligible rollover distributions, where 20% withholding applies unless directly rolled over (see Topic No. 413).
Estimated Tax Payments
If withholding does not cover your total tax liability, you may need to make estimated tax payments.
For more details on:
Increasing withholding
Avoiding underpayment penalties
Making estimated payments
Refer to Publication 505, Tax Withholding and Estimated Tax.