Although many companies now offer a 401(k) retirement plan to their employees, some employers still provide a traditional pension. Reporting pension income on a tax return is similar to reporting 401(k) distributions, unless the taxable portion of a pension has not been determined by the pension plan trustee.
Unlike a 401(k) plan with defined contribution amounts, a traditional pension is referred to as a defined benefit plan. All 401(k) plans and most traditional pensions are known as qualified plans, meaning that they can hold tax-deferred funds by virtue of complying with the applicable sections of the tax code. The similarities continue each year, as beneficiaries of 401(k) plans and pensions both receive the same type of year-end tax form.
IRS Form 1099-R is used to report payments made to pension recipients, as well as payments from 401(k) plans or individual retirement accounts. For most retirees, Form 1099-R reports the gross distribution on the first line, immediately followed by the taxable amount on the next line. For defined contribution plans, the taxable portion should always be already included. For some traditional pensions, however, the taxable amount on Form 1099-R may be missing.
If the line on Form 1099-R designated for the taxable amount is blank, the checkbox directly underneath it should be marked, indicating that the taxable amount is not determined. If the checkbox is marked, you will have to calculate the taxable amount yourself.
Identifying sources of pension funds
If your employer paid for the entire cost of your pension, the payments are fully taxable. If you contributed a percentage of your after-tax earnings while still employed there, that portion should not be taxed again. There is a series of calculations necessary to separate your contributions from those of your employer to arrive at a specific taxable amount.
Simplified method worksheet
If necessary, the taxable amount of traditional pension payments can be calculated by use of a technique referred to as the simplified method. Using the simplified method, a portion of each pension payment is deemed to be a return of your after-tax contributions. The remainder of each payment is taxable. A simplified method worksheet is included in the instructions for Form 1040.
The worksheet is completed only for the year you begin receiving the pension. The tax-free amount remains unchanged in each subsequent year, even if the total pension amounts change. The pension becomes fully taxable only if you live long enough to recover all your contributions. Contact a tax adviser at a company like Balkcom Pearsall & Parrish CPA's PA for more advice on retirement accounts.Share