Pensions and Annuities

What are pensions and annuities?

Generally, pensions and annuities provide cash payments to you after retirement. The term of the payments may be for life or for a fixed time period. A withdrawal or distribution generally cannot be taken before the normal retirement age as specified in your retirement plan without a penalty being charged. However some retirement plans allow for early retirement.

What is a pension?

A pension provides specific payments to an employee or survivor (the beneficiary) after retirement from work. The payments are made regularly and are for past services with an employer.

What is an annuity?

An annuity provides payments under a contract from an employer or an insurance company, trust company, or an individual. Payments are made at regular intervals over a period of more than one full year.

What is my cost in a retirement plan?

Your cost in a retirement plan is everything that you paid into the retirement plan that was not deducted or excluded from income. For example, your 401k contributions which reduced your wages for income tax are not considered part of our cost in the retirement plan. Cost also includes amounts your employer paid that were taxable to you when paid.

Are pensions and annuities taxable?

Pensions and annuities may be either partially or fully taxable depending upon the extent of your contribution to the retirement plan.

An employee pension is fully taxable if you did not contribute to the cost of the pension plan or annuity and your employer did not withhold part of the cost of the contract from your pay while you worked.

An employee pension is partially taxable if you did contribute to it. The amount you put into the pension (your cost) was taxed as part of your wages at the time you contributed and is therefore nontaxable at retirement. (It is not taxed again.)

Reporting pensions and annuities on 1099-R

For employers other than US Civil Service and the Railroad Retirement board, the total payment (box 1 of Form 1099-R) and the taxable payment (box 2a) should be calculated based on the system the employer uses. The tax free amount of the contributions for this tax year should show in box 5 of Form 1099R.

The starting date of your annuity determines how the taxable part each year is figured. If your annuity starting date is after November 18, 1996, and your payments are from a qualified plan, you MUST use the Simplified Method.

If your annuity starting date is after July 1, 1986 but before November 19, 1996 and you use the Simplified Method, continue to use it until you recover all of your cost in the plan.