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- A pension plan is an employer- or union-funded retirement benefit, and it comes in several forms, including contributory plans like 401(k)s and 403(b)s, non-contributory employer-funded plans, and annuities, each with different funding and tax rules.
- Whether pension and annuity payments are fully or partially taxable depends on whether contributions were made with pre-tax or after-tax dollars.
- Report pension income on Form 1040 using the details from Form 1099-R, which your plan administrator sends you.
- Sixteen states offer full or partial exemptions on pension income from state tax; however, the specific rules and eligibility requirements vary by state.
- Withdrawing pension funds before age 59½ generally triggers a 10% penalty on top of any income tax owed.
- If your plan allows a lump-sum payout and you've left your employer, you can roll the balance into a traditional IRA tax-free, but rolling into a Roth IRA triggers tax on the rollover.
- You can begin taking distributions penalty-free at 59½, and you're required to start by April 1 of the year after you turn 73.
- Pension income is taxed at the same rate regardless of age.
- Pensions are only partly taxable when you make after-tax contributions. You can withdraw that portion tax-free, while growth and pre-tax contributions are taxed as regular income.
If you collect a pension when you retire, you may need to report it on your taxes. Find out how taxes apply to different types of pension plans.
What is a pension plan?
A pension plan is a retirement benefit for employees in which employers and/or unions promise to contribute towards their future retirement. There are many types of pension or retirement plans available to taxpayers, with many similarities and differences among them. The one thing that is the same across the board is that there is a 10% additional tax on most plan distributions taken before age 59½.
What are the different types of pension plans?
- Contributory plans allow employees to fully or partially fund their own retirement account.
- A deferred-compensation plan is a contributory plan. The contribution is not subject to federal income taxes until you withdraw the funds from the plan. A 401(k) plan is one of the most common types of deferred-compensation plans.
- The 401(k) or 403(b) plan is another common form of contributory retirement plan. Employers can set up additional rules in 401(k) and 403(b) deferred-compensation plans to allow you to treat all or 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 are generally fully funded by the employer, which means that you, as the employee, cannot contribute. You enter into a contract with your employer requiring a specified number of years of employment in exchange for a specific amount of monthly retirement income once you fulfill your obligation. All the distributions from this type of retirement plan are taxable when you withdraw them.
- An annuity is a pension plan that requires you to pay for a future retirement benefit. An example of this type of plan is a Civil Service pension. The payment is deducted from your paycheck every payday after tax is deducted. A portion of each distribution is not taxed.
Are pension and annuity payments taxable?
It depends on whether you and your employer funded your account with pre-tax or after-tax dollars.
Your pension and/or annuity payments may be fully taxable if:
- You made no contributions with after-tax money.
- Your employer made 100% of the contributions.
- You used pre-tax money to fund a qualified annuity.
Your pension and/or annuity payments may be partially taxable if:
You made contributions with after-tax dollars. You can withdraw the portion representing your after-tax investment tax free. The portion of the payment that represents growth or pre-tax contributions is taxed as regular income.
It’s also important to note that if you’re younger than 59½ or haven’t reached retirement, making a withdrawal triggers a 10% tax penalty on top of the regular income tax rate.
How to report pension income
Report your pension income on Form 1040, U.S. Individual Income Tax Return. You can find this information on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., which your plan administrator will use to report your pension income to you and the IRS.
Your plan administrator should send you a copy of Form 1099-R, but even if you don’t receive one, you still may owe full or partial tax on pension or annuity payments.
What states don't tax pension income?
There are 16 states that exempt (some or all) pension income from state tax:
- Alabama: Income from military retirement, government, and private-sector defined-benefit (DB) pension is exempt from state tax. However, distributions from a traditional 401(k) and IRA are taxed as regular income.
- Alaska: All income is exempt from state tax, including pension income.
- Florida: All income is exempt from state tax, including pension income.
- Hawaii: Income from a private or public pension is exempt from state tax, but only if you did not make contributions. If you did make contributions, withdrawals are subject to partial state tax.
- Illinois: Income from private, qualified employee benefit plans, government, and military pensions is all exempt from state tax.
- Iowa: Taxpayers who are 55 or older are not required to pay state tax on income from qualified pensions.
- Michigan: Pension income is exempt from state tax.
- Mississippi: As long as it isn’t for early retirement, pension income is exempt from state tax.
- Nevada: All income is exempt from state tax, including pension income.
- New Hampshire: All income is exempt from state tax, including pension income.
- Pennsylvania: As long as it isn’t for early retirement, pension income from an employee-sponsored retirement plan is exempt from state tax.
- South Dakota: All income is exempt from state tax, including pension income.
- Tennessee: All income is exempt from state tax, including pension income.
- Texas: All income is exempt from state tax, including pension income.
- Washington: All income is exempt from state tax, including pension income.
- Wyoming: All income is exempt from state tax, including pension income.
What happens if you take an early pension distribution?
If you take an early pension distribution (before you are at least 59½ years old), it’s subject to a 10% penalty, in addition to any income tax you owe on the distributed funds.
Can you roll your pension into an IRA?
Yes, if your pension plan offers a lump-sum payment option and you are no longer with your employer, you can roll your balance into an Individual Retirement Account (IRA).
You may be able to roll over the balance directly into an IRA, or your plan administrator may send you a check. You must deposit it in your new IRA within 60 days. Keep in mind that you must roll the funds over into a traditional IRA to avoid current tax. If you roll them over into a Roth IRA, you will have to pay tax on the rollover.
When do you have to start taking pension distributions?
You can start taking pension distributions when you are at least 59½ years old without triggering the 10% penalty. You must start taking pension distributions by April 1 of the year after you turn 73, and by December 31 of each subsequent year.
Do I have to pay taxes on my pension after age 65?
Yes, your pension income is subject to the same income tax rate, regardless of your age. The only difference is if you are younger than 59½, your pension income also has a 10% early withdrawal penalty.
Why is my pension only partly taxable?
Your pension distributions may be partially taxable if you made some after-tax contributions to your plan. The portion representing your initial investment is tax free; however, any growth is taxed as regular income.
Is pension rollover taxable?
As long as you roll the funds over into a traditional plan that treats contributions the same way, the rollover is tax free. But, if you roll the funds over into a Roth account (where you pay tax on contributions but not on withdrawals), the rollover is taxed as regular income.
Have questions or concerns about pensions and annuity income, and how it’s taxed? Reach out to your local Jackson Hewitt Tax Pro any time. We’re open all year and ready to help. Find tax services near you, then walk in or book now.
About the Author
Sharon Brucker is a Senior Tax Research Analyst at Jackson Hewitt Tax Services who specializes in consumer income tax and estate and trust issues. A Certified Public Accountant (CPA) with a Master of Business Administration (MBA) and more than 35 years of experience, Sharon helps to ensure that the most current IRS tax information is distributed throughout Jackson Hewitt and its franchisees. She also simplifies complex tax laws for Tax Pros and clients alike.
*This content is for general informational purposes only. It is not intended to be comprehensive and should not be construed as professional tax or financial advice for any specific individual tax situation. Taxpayers should always consult a qualified professional for individual guidance. This information constitutes a solicitation under the Treasury Department's Circular 230. Most offices are independently owned and operated.
