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Taxation of Retirement Benefits - Pensions and Annuities

These distributions from your retirement plan are fully taxable:

  • All contributions your company made into your retirement plan
  • Pre-tax contributions -- like to a 401(k) plan -- you made. They're taxable since you didn't pay taxes on your contributions when you made them.

After-tax contributions you make into a retirement plan are tax-free upon distribution. This is true since you paid taxes on the contributions when you made them. 

The IRS has several methods for figuring the taxable part of your distribution. The method used depends upon the year you start receiving your retirement.

Simplified Method

The simplified method allows you to figure the tax-free part of each annuity payment. You might have made some after-tax contributions. If so, divide your cost by the total number of anticipated monthly payments. For an annuity not payable for life, this number is the number of monthly annuity payments under the contract.

For an annuity payable for life, this number is based upon the age you started receiving the annuity. It's figured from this table:

Use Table 1 for single life payments and Table 2 for joint life payments.

 

  Table 1  
Your age at the annuity starting date: Number of payments for tax purposes if your annuity start date was before Nov. 19, 1996 Number of payments for tax purposes if your annuity start date was after Nov. 19, 1996
55 or under 300 360
56-60 260 310
61-65 240 260
66-70 170 210
71 or older 120 169
     
  Table 2  
Combined ages on the annuity starting date were: Number of payments for tax purposes   
110 or under 410  
111-120 360  
121-130 310  
131-140 260  
141 or older 210  

 

After you recover all of your after-tax contributions, you can’t exclude any other benefits from tax. However, the rules differ for those who die before recovering all contributions. In that case, the person doing the deceased's taxes can deduct the remaining contributions on the final return.

You can use the simplified method if your pension or annuity meets all of these:

  • The payments are for the annuitant's life or the joint lives of the annuitant and a beneficiary. The payments must be from one of these:
    • Qualified pension
    • Profit-sharing plan
    • Stock bonus plan
    • Qualified employee annuity plan
    • Tax-sheltered annuity plan (403(b) plan)
  • The annuitant must be under age 75 when the payments begin. If 75 or older, the guaranteed payments must last fewer than five years.

Annuity Income

Distributions you receive from annuities you bought with after-tax money will have a part that’s tax-free. Only the premiums you paid are excluded from tax. The Form 1099-R the insurance company sends you should show you the taxable amount.

Commercial Annuities

For a commercial annuity, you can't use the simplified method to calculate the tax-free portion of each payment. You must figure the tax-free part by using the ratio of your cost divided by your total expected return.

To learn more, see Publication 575: Pension and Annuity Income at www.irs.gov.

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