Taxable Portion of Your Pensions and Annuities
The IRS says that your payments are partially taxable if you made your contributions to your pension or annuity with after-tax dollars. You won’t pay tax on the portion of the payments that represent a return of the after-tax amount you paid in. These contributions represent your cost in the plan or investment. They include amounts that your employer might have contributed that were taxable to you as income at the time they were made. Any contributions that you made with after-tax income, those for which you never took a tax deduction, aren’t taxable to you at the time of distribution. These include contributions your employer made on your behalf but which were attributed to you as income, so you claimed them on your tax returns and paid taxes on the amounts when they were contributed.
The General Rule vs. the Simplified Method
You must determine the method by which the remaining amounts will be taxed. Partly taxable pension plans and annuities are taxed under either the General Rule or the Simplified Method. You’re restricted to using the General Rule if the starting date of your annuity was between July 1, 1986, and November 18, 1996, and if you don’t qualify to use the Simplified Method. You must also use the General Rule if your starting date is after November 18, 1996, you were age 75 or older as of that date, and your payments were guaranteed for at least five years. You’re limited to using the General Rule if you’ve received payments from a nonqualified plan. A qualified retirement plan is a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan.
The General Rule
The General Rule requires that you use the life expectancy or actuarial tables provided by the IRS to figure the taxable and tax-free portions of your payments. They’re included in IRS Publication 939, General Rule for Pensions and Annuities. The publication also walks you through the calculations for your taxable pension and annuity under the General Rule. The easiest, safest option might be to consult a tax professional or have the IRS make these calculations for you.
The Simplified Method
The IRS says you can use the Simplified Method to determine how much of your annuity or pension payments is taxable and how much is tax-free if the starting date of payments was after November 18, 1996. The IRS provides a Simplified Method Worksheet to help you along.
How to Report Pension and Annuity Income
Separate any 1099-R statements you receive into two piles: those from your IRA and those from your pension or annuity plans. You’ll report your IRA distributions on lines 4a and 4b of the Form 1040. Report your pension and annuity distributions on lines 5a and 5b. The 5a column is for your total distributions. The 5b column segregates the taxable amount.
