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.
more information about pensions, read more below:
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 $61,000 if Married Filing Jointly, $45,750
if Head of Household, and $30,500 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.
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
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
- You received all of your contributions tax free in prior
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.
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
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.
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.
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
- Distributions required by the courts in a divorce
- 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
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.