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IRS - Pensions – The general rule and the simplified method
IRS - Pensions – The general rule and the simplified method

Methods for determining the taxable and tax-free portions of pension or annuity payments.

Nicole Lacorte avatar
Written by Nicole Lacorte
Updated over 2 weeks ago

If you made after-tax contributions to your pension or annuity plan, you can exclude part of your distributions from taxable income. The tax-free portion must be determined when payments first begin and generally remains consistent each year, even if payment amounts change. However, the total tax-free amount is generally limited to your total cost (also known as "basis" or "investment in the contract").

For details on determining total cost, refer to Publication 575, Pension and Annuity Income.

The General Rule

If you receive annuity payments from a nonqualified retirement plan, you must use the general rule. This method calculates the taxable and tax-free portions of annuity payments using IRS life expectancy tables.

  • The IRS can calculate the tax-free portion for a fee.

  • For more details, refer to Publication 939, General Rule for Pensions and Annuities.

The Simplified Method

If you receive annuity payments from a qualified retirement plan, you generally must use the simplified method to determine the taxable and tax-free portions.

A qualified retirement plan includes:

  • A qualified employee plan

  • A qualified employee annuity

  • A tax-sheltered annuity plan or contract

To use the simplified method, complete the Simplified Method Worksheet found in:

  • Instructions for Form 1040 (or Form 1040-SR)

  • Publication 575

If you receive U.S. Civil Service retirement benefits, refer to Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits for special rules.

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