How Much Tax Is Owed on a Pension Distribution?
Your pension distribution in most cases will be either fully or partially taxable. At the end of the year, your pension administrator sends you a Form 1099. This form lists the amount you should report as taxable income. The amount of tax you will owe depends on your overall tax bracket in the year you received the funds. However, if you take a distribution before retirement age, you could also owe an additional federal penalty tax. While state tax laws vary, most allow a tax break on pension distributions.
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Basis
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If you made after-tax contributions to your pension, your distributions will not be fully taxable. The total of the after-tax contributions is known as the cost basis. Your pension fund administrator does not include the cost basis in the taxable portion of your distribution listed on your 1099 form. If you receive a lifetime distribution, a portion of each payment represents your basis. Therefore, a part of each payment is not taxable. If you did not make any taxable contributions, your entire pension will be taxable. By law, your pension administrator must report the taxable part of you distribution to you on Form 1099.
Penalty
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In some cases, if you take a pension distribution before age 59 1/2, you will incur a penalty. The penalty is 10 percent on the amount of the distribution in addition regular taxes. You pay this when you file your return. There are exceptions to this rule, however. For example, you can avoid the tax if you are retiring and are at least age 55. Also, you are not penalized if your distribution is part of a lifetime series of substantially equal payments
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States
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You may not owe state taxes on your pension distribution. Seven states do not have income taxes. Additionally, most of the other states allow exclusions for pension distributions. Generally, pension income up to a specific dollar limit is excluded from taxation when you reach a certain age. The age limit is usually 62 or 65. The exclusion has a wide range from $2,000 to $41,000. The typical range for most states is $12,000 to $24,000.
Tax Liability
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Pension distributions are taxed as income when withdrawn from your plan. The distribution will be counted as additional income when you file your tax return Therefore, the amount of federal tax you will owe depends on your total income for the year. Your state tax liability depends on where you reside and your age. If you qualify for exclusion in a state with a generous limit you will not owe state taxes.
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