Some distributions from retirement plans, allotted from qualifying annuity or pension plans through your employer, may be taxable.
If any of the following statements are true, your benefits may be taxable:
- You didn’t contribute to your pension or you aren’t a contributing party to the annuity.
- Your employer didn’t deduct the contributions from your salary.
- You received your contributions without any applicable taxes in years previous.
Annuity payments may be partially taxable, provided you contributed the funds after they were taxed. You will not be taxed again on the portion you contributed post-tax, and is considered to be your investment in the contract. There are two methods to calculate the tax on pensions that are partially taxable: The General Rule and the Simplified Method. The Simplified Method is recommended for all annuity payments starting after November 18, 1996.
You may be subject to a penalty if you accept pension retirement benefits before you reach age 59 ½. Unless you qualify for an exemption, the penalty is an additional 10% tax. There are some tax-free distributions which are not subject to the penalty for early distribution. Examples of tax-free distributions include:
- A portion of a series of substantial payments, processed in a specific timeframe that begin immediately after your last day of service.
- Permanent disability distributions
- Any payments distributed after the original owner of the plan has died
- Distributions received after service and either in or after you reach 55 years of age.
Generally, federal income tax will apply to any portion of payments that are taxable.
You can chose to not have your tax withheld from your benefits during distribution, or you can specify exactly how much tax to withhold. To do so, you should provide the payer with a Form W-4, Withholding Certificate for Pension or Annuity Payments. This is only applicable for U.S. citizens and resident aliens who can provide a U.S. address (including possessions). The tax is calculated similarly to salaries and wages. Without the form, you are considered a married taxpayer with three withholding allowances.
You need to provide an accurate Social Security number along with the form, otherwise you will be taxed as an individual with no withholdings.
If you don’t have enough tax withheld, you will be responsible for making estimated tax payments to cover the underpayment.
Qualified retirement plans distributing non-periodic payments have their own set of rules. If you accept a distribution that is eligible to be rolled over, you are required to withhold 20%, regardless of what you do with it later. A direct rollover will help you avoid the 20% withholding.