Pensions are often taxable when they are contributed to using pre-tax dollars. In other words, if your employer takes money out of your paycheck before deducting taxes, your taxable income becomes lower making the contribution pre-tax. When the time comes to withdraw from the pension, the income may then be taxed.(1)
• Taxable and partially taxable pensions
In the case of pensions contributed to with after-tax dollars, the amount contributed to the pension plan is tax-free when it is a qualified distribution. Qualified distributions meet specific criteria such as contribution amount which are enforced by tax regulators such as the U.S. Internal Revenue Service. Overall tax on contributions can be reduced further with the savers credit in some cases. According to the IRS, the savers credit allows an annual tax credit up to $1000 for single tax payers with incomes below set limits who make contributions to applicable pension plans.
Retirement income from Roth IRAs is subject to qualified distributions, but earnings on the post-tax contributions are tax deferred meaning it is taxable upon withdrawal. In other words, since Roth IRA contributions are post-tax, those contributions are generally non-taxable upon withdrawal. However, a tax penalty of 10% applies to non-qualified pension withdrawals; for example, withdrawals prior to age 59.5 years of age.(1)
• Tax exempt pensions
Some pensions are exempt from taxation; examples of these pensions include Veterans pensions and Railroad worker pensions. Depending on which state one resides in, pension income may or may not be taxable as states are allowed to tax or not tax income independently of the federal government.(2)
• Pension laws and rules
Several laws regulate pensions including the Employee Retirement Income Security Act (ERISA), the Pension Protection Act of 2006 and tax regulations set forth in Title 26 of the U.S. Code. IRS instructions and rules regarding pension income can be found in IRS Publication 575.
The taxation of pensions can be affected by a number of circumstances and rules; for example rollover of non-qualified pensions to qualified pensions may be taxable prior to rollover or as a condition of rollover. In other words, if a pension contributed to with pre-tax dollars is rolled over into a pension typically contributed to with post-tax dollars, the portion of the pension that was pre-tax will become taxable upon withdrawal.
An important determinant of pension taxation is the cost i.e. the amount contributed to the pension plan by the employee. As with Roth IRAs, earnings on money put into a retirement plan is generally not exempt from taxation; for example capital appreciation or capital gains. Pension income that is not withdrawn during retirement may be subject to an additional 50% tax if it does not meet the minimum IRS distribution amount.(5) In the case of estate transfer, pension income with a trust fund beneficiary may avoid estate taxes.
• International pension income
International pension income may be taxable in the country of origination and partially exempt from tax in the U.S. depending on the pension type, and specific tax treaty agreement between the countries.(4) The IRS recommends contacting the country's Department of Revenue to clarify how the pension income should be taxed. The IRS also claims that in cases of Social Security Income from other countries, the pension income is typically taxable in the country of origin.
• Taxable and partially taxable pensions
In the case of pensions contributed to with after-tax dollars, the amount contributed to the pension plan is tax-free when it is a qualified distribution. Qualified distributions meet specific criteria such as contribution amount which are enforced by tax regulators such as the U.S. Internal Revenue Service. Overall tax on contributions can be reduced further with the savers credit in some cases. According to the IRS, the savers credit allows an annual tax credit up to $1000 for single tax payers with incomes below set limits who make contributions to applicable pension plans.
Retirement income from Roth IRAs is subject to qualified distributions, but earnings on the post-tax contributions are tax deferred meaning it is taxable upon withdrawal. In other words, since Roth IRA contributions are post-tax, those contributions are generally non-taxable upon withdrawal. However, a tax penalty of 10% applies to non-qualified pension withdrawals; for example, withdrawals prior to age 59.5 years of age.(1)
• Tax exempt pensions
Some pensions are exempt from taxation; examples of these pensions include Veterans pensions and Railroad worker pensions. Depending on which state one resides in, pension income may or may not be taxable as states are allowed to tax or not tax income independently of the federal government.(2)
• Pension laws and rules
Several laws regulate pensions including the Employee Retirement Income Security Act (ERISA), the Pension Protection Act of 2006 and tax regulations set forth in Title 26 of the U.S. Code. IRS instructions and rules regarding pension income can be found in IRS Publication 575.
The taxation of pensions can be affected by a number of circumstances and rules; for example rollover of non-qualified pensions to qualified pensions may be taxable prior to rollover or as a condition of rollover. In other words, if a pension contributed to with pre-tax dollars is rolled over into a pension typically contributed to with post-tax dollars, the portion of the pension that was pre-tax will become taxable upon withdrawal.
An important determinant of pension taxation is the cost i.e. the amount contributed to the pension plan by the employee. As with Roth IRAs, earnings on money put into a retirement plan is generally not exempt from taxation; for example capital appreciation or capital gains. Pension income that is not withdrawn during retirement may be subject to an additional 50% tax if it does not meet the minimum IRS distribution amount.(5) In the case of estate transfer, pension income with a trust fund beneficiary may avoid estate taxes.
• International pension income
International pension income may be taxable in the country of origination and partially exempt from tax in the U.S. depending on the pension type, and specific tax treaty agreement between the countries.(4) The IRS recommends contacting the country's Department of Revenue to clarify how the pension income should be taxed. The IRS also claims that in cases of Social Security Income from other countries, the pension income is typically taxable in the country of origin.
Sources:
1. http://bit.ly/9L8dVH (Internal Revenue Service)
2. http://bit.ly/jeOTK (Retirement Living)
3. http://bit.ly/cOeBcu (Department of Labor)
4. http://bit.ly/cjPoR6 (IRS: International pensions)
5. http://bit.ly/bJENMf (IRS: Publication 575)
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