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Taxation: Pensions and Annuities FAQs

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Do you have a 401(k) plan? Many people have pensions and annuities to help them live a comfortable retirement lifestyle. However, there are tax implications with the money from these plans. The Internal Revenue Service (IRS) offers some guidelines to help you understand the tax regulations. Here are some frequently asked questions about the taxation of pensions and annuities.


Q: I was thinking about contributing to a 401(k) plan. What exactly is it?

  • It's a retirement plan sponsored by a company or employer in which you can contribute part of your earnings. The interest you earn from the plan is tax-deferred until you withdraw the money.

Q: Can I put most of my earnings into a 401(k) plan?

  • No, there are legal limits to how much money you can contribute to a 401(k) plan. These limits are set each year.

Q: Do I have to pay taxes on any distributions from a pension or annuity?

  • Any pension or annuity payments from a qualified employer retirement plan may be fully or partially taxable. The money is fully taxable if:

    • You didn't pay any money for the annuity or pension
    • No contributions were withheld from your salary, or
    • You already have received the contributions you gave in past years tax free

    The payments are partially taxable if you have contributed after-tax money to the pension or annuity. You don't have to pay taxes on the money that represents the after-tax amount you've already paid.

Q: Are there any financial penalties for taking money out of a retirement plan early?

  • You usually have to pay a 10 percent additional tax on any distributions you take before you reach the age of 59 1/2.

Q:

Are there any general exceptions to the 10 percent additional tax for early distributions?

  • There are a few general exceptions to the additional tax. It doesn't apply if the distributions are part of a series of payments made at least annually for the rest of your life. The payments have to be substantially equal. In addition, the distributions must start after service separation if they're from a qualified retirement plan.

    The additional tax also won't apply if they're made on the basis that you're totally and permanently disabled. If you're not the retirement plan participant or the annuity contract holder, the additional tax won't apply if you receive the distributions on or after his death. There are a few other additional exceptions for qualified retirement plans and nonqualified annuity contracts.

Q: May I roll over money that was distributed from a retirement plan into another retirement plan?

  • You can roll over retirement distributions up to the 60th day after you received the money.

Q: Will the IRS help me if I can't figure out the taxable portion of my pension or annuity?

  • The IRS will figure out your taxable portion for a fee.