Pensions are taxable income in most cases, but the amount you owe depends on what kind of pension you have and how you funded it

Whether you pay tax on your pension comes down to one question: did you or your employer pay the contributions with pre-tax dollars? If yes, the money you receive is taxable. If you paid with after-tax dollars, you only pay tax on the growth and earnings, not on what you put in. The IRS treats pensions the same way it treats other retirement income — you report what you receive on your tax return, and the amount owed depends on your total income for the year and your filing status.

Most traditional pensions — the kind employers pay into on your behalf — are funded with pre-tax money, which means your full pension payment counts as taxable income. Military pensions, federal employee pensions, and most private company pensions work this way. If you contributed to a pension yourself using after-tax dollars, you can exclude that portion from your taxable income, but you will need documentation showing what you paid in.

Key Takeaways

  • Traditional pensions funded with pre-tax contributions are fully taxable when you receive them.
  • If you contributed after-tax dollars to your pension, only the earnings and employer contributions are taxed, not your original contributions.
  • You report pension income on your tax return using Form 1099-R, which your pension provider sends you by January 31 each year.
  • Pension income counts toward your total income for the year and may push you into a higher tax bracket or affect other tax benefits you receive.
  • Some pensions allow you to choose how much tax is withheld from each payment, which affects how much you owe when you file.

How the IRS determines what portion of your pension is taxable

The IRS uses a formula called the exclusion ratio to figure out how much of your pension is tax-free if you contributed after-tax money. The formula divides your total contributions by the total amount you are expected to receive over your lifetime. That percentage stays the same for every payment you get, even if you live longer than expected.

For example, if you contributed $50,000 after-tax and the IRS calculates you will receive $200,000 total over your lifetime, 25 percent of each payment is tax-free and 75 percent is taxable. Your pension provider should calculate this for you and report it on Form 1099-R, the document you use to report pension income on your tax return. If you are unsure whether you made after-tax contributions, check your old pay stubs or contact your pension administrator — they keep records of what you paid in.

Military and federal employee pensions

Military pensions are fully taxable as ordinary income. The Department of Defense does not withhold federal tax automatically, so you may need to make quarterly estimated tax payments or request withholding from your pension check. You report military pension income on Form 1099-R, just like any other pension.

Federal employee pensions — including those from the Civil Service Retirement System (CSRS) and the Federal Employees Retirement System (FERS) — are also fully taxable. FERS pensions are treated as ordinary income. CSRS pensions may have a small tax-free portion if you made contributions before 1984, but most of the payment is taxable. Federal employees can request tax withholding when they start receiving their pension, and the Office of Personnel Management will send Form 1099-R by January 31.

How pension income affects your overall tax situation

Pension income counts as part of your total income for the year, which means it can push you into a higher tax bracket and increase the tax you owe on all your income. It also affects whether you can claim certain tax breaks. For example, if your pension income plus other income exceeds certain thresholds, you may not be able to deduct traditional IRA contributions, and you may owe tax on Social Security benefits you receive.

The IRS publishes income limits each year for different filing statuses. If you are single and your modified adjusted gross income exceeds $68,000 in 2023, for example, you cannot make a deductible contribution to a traditional IRA (the limit varies by year and filing status). Pension income counts toward that limit. You should factor in your pension amount when you plan your overall tax picture for the year.

Tax withholding from your pension payment

Your pension provider can withhold federal income tax from each payment you receive. When you start your pension, you will receive a Form W-4P, which asks how much tax you want withheld. You can choose to have no tax withheld, a flat dollar amount withheld, or a percentage of each payment withheld. The more tax you have withheld, the less you owe when you file your return — but you also receive less money each month.

If you do not request withholding and you owe a large amount at tax time, the IRS may charge you a penalty for underpayment. You can change your withholding at any time by submitting a new Form W-4P to your pension administrator. Many people choose to have enough withheld so they owe little or nothing when they file, while others prefer to receive the full payment and handle the tax bill separately.

State and local taxes on pensions

Some states do not tax pension income at all, while others tax it like any other income. A few states offer partial exemptions for military or federal pensions. The state where you live when you receive the pension is generally the state that taxes it, not the state where you worked or where the pension is from.

If you move to a different state after you start receiving your pension, you may owe taxes to your new state. Some states have reciprocal agreements with neighboring states that affect how pension income is taxed. You should check your state's tax rules or speak with a tax preparer who knows your state's pension tax treatment, because the rules vary widely.

What to do when you receive Form 1099-R

Your pension provider sends Form 1099-R by January 31 each year. This form shows the total amount you received, how much federal tax was withheld, and whether any of the payment was a non-taxable return of your contributions. Box 1 shows the gross distribution, and Box 2a shows the taxable amount. You report this information on your tax return using Schedule 1 (Form 1040) or the appropriate line on your return, depending on your filing software or tax preparer.

Keep your Form 1099-R with your tax records for at least three years. If the form shows an incorrect amount or if you believe the taxable portion was calculated wrong, contact your pension administrator to request a corrected form. Do not file your return until you have the correct 1099-R, because the IRS matches the information on your return to the copy the pension provider sends them.

Frequently Asked Questions

Do I have to pay tax on my entire pension payment?

Not necessarily. If you made after-tax contributions to your pension, that portion is not taxed again. Your pension provider calculates the exclusion ratio and reports the taxable amount on Form 1099-R. Only the taxable portion counts as income on your return.

What happens if I did not have enough tax withheld from my pension?

You will owe the difference when you file your tax return. If you owe a large amount and did not make quarterly estimated payments, you may also owe a penalty for underpayment. You can adjust your withholding on Form W-4P to have more tax taken out of future payments.

Can I avoid paying tax on my pension by moving to another state?

No. The state where you live when you receive the pension generally taxes it, regardless of where you worked. A few states do not tax pension income at all, but you cannot avoid federal tax by moving. Check your new state's rules if you relocate after you start receiving your pension.

Is my spouse's pension income taxable if I file jointly?

Yes. Pension income is taxable to the person who receives it. If you file a joint return, both your pension and your spouse's pension count toward your combined income for the year, which may affect your tax bracket and other tax benefits.

What if my pension provider did not send me a Form 1099-R?

Contact your pension administrator when ready and request a copy. You need this form to file your tax return accurately. If you do not receive it by February 15, you can file for an extension or contact the IRS for help locating the form.