Pension income is taxed as ordinary income by the federal government, and in most states by state government too

When you receive a pension check, the money counts as income for tax purposes. The IRS taxes it the same way it taxes wages from a job — at your ordinary income tax rate, which depends on how much total income you have that year. This is different from some other retirement money; for example, certain withdrawals from Roth accounts are not taxed at all. Your pension, though, is taxed every year you receive it, for as long as you receive it.

The amount of tax withheld from each pension payment depends on what you told your pension plan administrator on your W-4 form. You can change your withholding at any time by submitting a new form to your plan. If too little is withheld, you may owe money when you file your tax return. If too much is withheld, you get a refund.

Key Takeaways

  • Federal income tax is withheld from your pension check based on the W-4 form you completed with your pension plan.
  • Most states tax pension income as ordinary income, though a handful of states do not tax pensions at all.
  • If you have other income sources — Social Security, investment earnings, part-time work — your total income determines your tax bracket and how much you owe.
  • You can adjust your withholding by submitting a new W-4 to your pension plan if you are paying too much or too little in taxes.

Federal tax withholding and how it works

Your pension plan uses your W-4 form to calculate how much federal income tax to take out of each payment. The W-4 asks about your filing status, other income, and dependents. Based on your answers, the plan withholds a percentage of your pension payment and sends it to the IRS on your behalf.

The withholding is an estimate. It is meant to cover your actual tax bill, but it may not be exact. If you have a spouse who also works, or if you have investment income, or if you receive Social Security, your total tax picture is more complicated. You may need to adjust your W-4 to account for that other income.

You can request a new W-4 from your pension plan administrator at any time. Fill it out, return it to the plan, and your withholding will change on your next payment. There is no penalty for changing it, and you can change it as many times as you need to.

State income tax on pensions

Most states tax pension income as ordinary income, meaning it is subject to the same state income tax rate as wages. However, nine states do not tax pension income at all: Alaska, Florida, Illinois, Mississippi, Nevada, South Dakota, Tennessee, Texas, and Washington. If you live in one of these states, you will not owe state income tax on your pension, though you will still owe federal tax.

Some states tax pensions differently depending on where the money came from. For example, a few states do not tax military pensions but do tax civilian pensions. A handful of states exempt pensions only if you are over a certain age, usually 59½ or 62. Check your state's tax authority website or contact them directly to learn the rules for your specific situation.

If you moved to a new state after you started receiving your pension, you may owe taxes to both your old state and your new state for part of the year. Some states have agreements to avoid this double taxation, but not all do. Your pension plan can tell you which state to report your pension income to, but you may want to consult a tax preparer if you have moved recently.

How your total income affects your tax rate

The federal tax rate you pay on your pension depends on your total income for the year, not just your pension. If you have other income — from a part-time job, investment earnings, rental property, or Social Security — that income is added to your pension to determine your tax bracket.

This matters because the U.S. tax system is progressive: the more income you have, the higher your tax rate. If your pension alone would put you in the 12 percent bracket, but you also have investment income that pushes your total over the threshold for the 22 percent bracket, the portion of your income in that higher bracket is taxed at 22 percent. Your pension plan cannot know about your other income unless you tell it on your W-4, so you need to account for it yourself when you fill out the form.

Social Security and pension income together

If you receive both a pension and Social Security, the combination can affect how much of your Social Security is taxed. The IRS uses a formula called combined income to determine this. Combined income includes your adjusted gross income, plus nontaxable interest, plus half of your Social Security benefit.

If your combined income exceeds certain thresholds — $25,000 for single filers and $32,000 for married couples filing jointly — up to 50 percent of your Social Security benefit becomes taxable. If your combined income is even higher, up to 85 percent of your benefit can be taxed. This is separate from the tax on your pension itself; it is an additional tax on your Social Security.

Your pension plan will not know about your Social Security, so you need to factor this into your W-4. If you think your combined income will be high, you may want to increase your withholding to avoid owing money at tax time.

What happens if withholding is too low or too high

If your pension plan withholds less tax than you actually owe, you will have to pay the difference when you file your tax return. The IRS does not charge a penalty for underpayment if you owe less than $1,000, but if you owe more than that and did not pay enough throughout the year, you may face a penalty. You can avoid this by adjusting your W-4 now.

If your pension plan withholds more tax than you owe, you will receive a refund when you file your return. This is not a penalty — it is simply the government returning money you overpaid. However, many people prefer not to overpay, because it means less money in their pocket each month. If you are getting a large refund every year, you can reduce your withholding on your W-4 to bring home more of each payment.

Lump-sum pension payments and special tax rules

Some pension plans offer the option to take your entire benefit as a single lump-sum payment instead of monthly checks. A lump sum is taxed differently than monthly payments. The entire amount is considered income in the year you receive it, which can push you into a higher tax bracket for that year only.

If you receive a lump sum, your pension plan will withhold federal income tax based on the amount and your W-4. However, the withholding may not be enough to cover your actual tax bill, because the large one-time payment can create a spike in your income. Before you take a lump sum, consider talking to a tax preparer to estimate what you will owe and whether you should increase your withholding or set aside money to pay taxes.

Some lump-sum payments are may be able to access rollover distributions, which means you can move the money into an IRA or another retirement account without paying tax on it immediately. If you do a rollover, you avoid the tax spike in that year, but you will pay tax later when you withdraw the money from the IRA. This is a complex decision and depends on your specific situation.

Frequently Asked Questions

Do I have to pay taxes on my pension if I am retired?

Yes. Retirement status does not matter — if you receive pension income, it is taxed as ordinary income by the federal government and by most states. The only exception is if you live in one of the nine states that do not tax pensions, or if your state has a specific exemption for your type of pension.

Can I reduce my pension tax withholding to get more money each month?

Yes, by submitting a new W-4 form to your pension plan. However, if you reduce withholding and end up owing taxes at the end of the year, you will have to pay the full amount then. Make sure your new withholding will still cover what you actually owe, based on all your income sources.

What if I worked for the federal government or military — is my pension taxed differently?

Federal and military pensions are taxed as ordinary income by the federal government, just like other pensions. However, some states exempt military pensions from state income tax even if they tax civilian pensions. Check your state's rules to see if your military or federal pension qualifies for an exemption.

Will my pension affect my Medicare premiums or other benefits?

Pension income counts toward your total income, which can affect your Medicare Part B and Part D premiums if your income is high enough. It may also affect whether you can claim certain tax deductions or credits. The IRS uses your modified adjusted gross income to determine these thresholds, so your pension is part of that calculation.