Tax Topics

Jackson Hewitt® is here to help you understand complex tax laws so you can be better informed and take full advantage of tax law provisions.

These topics explore some of the more important aspects of complicated tax laws, in a manner that is understandable and concise.


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Pensions

Pension plans are set up and maintained through your employer. Your employer sets up a plan based on strict IRS guidelines and offers the plan to each of its employees. There are many types of plans available. The most common types of plans are as follows:

  • A deferred compensation plan is a pension that allows employees to voluntarily contribute part of their income each pay day to a retirement plan. The contribution is not subject to federal income taxes until the taxpayer withdraws the funds from the plan. Distributions from this type of retirement plan are taxable when received. A 401(k) plan is one of the most common types of deferred compensation plans.
  • Employers can set up additional rules in 401(k) and 403(b) deferred compensation plans to allow a taxpayer to treat all of part of elective deferrals as after-tax Roth contributions. You are not allowed to deduct contributions to a 401(k) or 403(b) plan that are treated as Roth contributions. These contributions are treated as regular taxable income on your Form W-2. The distributions from these accounts are tax-free under the same provisions as a Roth IRA.
  • Non-contributory plans do not allow any contributions by the employee. An example is the traditional Military Retirement Plan. The employer and employee enter into a contract requiring a specified number of years of employment in exchange for a specific amount of monthly retirement once the employee fulfills their obligation. All of the distributions from this type of retirement plan are taxable when received.
  • An annuity is a pension plan that requires employees to pay for a future retirement benefit. An example of this type of plan is a Civil Service pension. The payment is deducted from an employee's paycheck every payday after taxes are deducted. A portion of each distribution is not taxed.

For more information about pensions, read more below:

Credit for Contributions to an Employer Plan or an IRA

If you make eligible contributions to a qualified retirement plan, an eligible deferred compensation plan, or an IRA, you may qualify for the Retirement Savings Contributions Credit. The maximum credit is $1,000 ($2,000 if Married Filing Jointly). Certain restrictions apply:

  • No credit is allowed on returns with modified adjusted gross income over $59,000 if Married Filing Jointly, $44,250 if Head of Household, and $29,500 if Single, Qualifying Widow(er) with Dependent Child, or Married Filing Separately.
  • You must be age 18 or older to claim the credit. In addition, you cannot be a full-time student, or claimed as a dependent on another's return.
  • A distribution from a retirement plan any time in the preceding two tax years, in the current tax year, and up to the due date of the current year's return (including extensions) reduces the amount available for the credit.

This credit is in addition to any deduction or exclusion for the plan contribution. Use Form 8880, Credit for Qualified Retirement Savings Contributions, to calculate this credit.

Distributions from Retirement Plans

When you begin receiving periodic payments or distributions from your pension plan, you must determine whether the full amount you receive is taxable to you. If you have no cost in your pension plan, your payments are fully taxable. Generally, you have no cost in your plan if:

  • You did not pay anything or are not considered to have paid anything for your pension
  • Your employer did not withhold tax-deferred contributions from your salary
  • You received all of your contributions tax free in prior years

However, if you have a cost to recover from your pension plan, you can exclude part of each distribution payment from income as a recovery of your cost. Generally, you can recover the cost of your pension tax free over the period you are to receive the payments. This tax-free part of the payment is determined when your payments start and remains the same each year, even if the payment amount changes. The amount of each payment that is more than the tax-free part is taxable.

Generally, your plan administrator will have calculated the tax-free portion of your annual distribution and reported it correctly on Form 1099-R. If you must calculate the tax-free part of the payment, you can usually use the simplified method. You must use the general rule if your payments are from a nonqualified plan.

You determine which method to use when you begin receiving your payments, and you continue using the same method each year that you recover part of your cost.

Rollovers

You can transfer funds from your qualified retirement plan to an IRA or other qualified plan within 60 days of receiving a distribution without paying any income tax. The opportunity to roll over pension plan funds into alternate plans or an IRA is an ideal way for an employee who leaves their job to avoid the tax liability assessed when the plan is terminated and a distribution check is issued. The rollover is a tax benefit that eliminates the payment of taxes on a distribution made for any reason other than a regular retirement distribution. Retirement plan administrators/trustees are required by law to permit a transfer of funds from their retirement plan directly to another qualified plan. This is known as a "trustee-to-trustee"transfer. The law favors the "trustee-to-trustee" transfer and discourages "hand check" distributions, a distribution check made payable directly to the plan beneficiary, by requiring plans to withhold 20% of the distribution before a check is issued. Therefore, a check will be issued for only 80% of the total amount distributed. This can be a "tax trap" for those who want to roll over a distribution but do not have the funds available equal to the amount withheld. The 20% withheld needs to be replaced from other sources and included as part of the rollover within the 60-day period or the 20% will be considered to have been distributed and subject to taxes. 


The IRS may waive the 60-day requirement for rollovers from pensions if you have suffered from a casualty, disaster, or other event beyond your reasonable control that prevents you from meeting the 60-day rule.

Early Distributions

To discourage the use of pension funds for purposes other than normal retirement, the law imposes additional taxes on early distributions of those funds. Generally, if you receive distributions from your pension plan before reaching age 59 and one half, you will be subject to a 10% additional tax on the part you must include in your gross income unless you meet one of the exceptions. Some exceptions to the additional tax are:

  • Distributions made as a part of a series of substantially equal periodic payments for your life beginning after separation from service
  • Distributions made because you are permanently and totally disabled
  • Distributions because you are age 55 or older and retired or separated from service
  • Distributions required by the courts in a divorce settlement
  • Distributions used to pay deductible medical expenses (expenses greater than 7.5% of adjusted gross income) whether or not you itemize your deductions
  • Distributions from an ESOP for dividends on employer securities held by the plan
  • Distributions due to an IRS levy on the plan
  • Distributions to a beneficiary of a deceased taxpayer

Contact your neighborhood Jackson Hewitt office for more information. Use the office locator feature available on this Web site or call 1-800-234-1040 to find the Jackson Hewitt location most convenient to you.