Pension income is taxed as ordinary income by the federal government and most states

When you receive a pension payment, the IRS treats it the same way it treats wages from a job. You owe federal income tax on the full amount you receive each month or year, depending on how your pension is structured. The tax rate depends on your total income for the year and your filing status — the more you earn from all sources combined, the higher your tax bracket.

Most pension administrators automatically withhold federal income tax from your payments before you receive the money. This withholding is an estimate based on a form you fill out (usually a W-4P) when you start receiving your pension. If too much is withheld, you get a refund when you file your tax return. If too little is withheld, you may owe money at tax time.

State income tax works the same way: your pension is subject to state tax in most states, though a handful do not tax pension income at all. The states that do not tax pensions are Alaska, Florida, Illinois, Mississippi, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. If you live in a state that taxes pensions, your pension administrator will withhold state tax as well.

Key Takeaways

  • Federal income tax is owed on all pension income, and your pension administrator usually withholds it automatically based on a form you complete.
  • State income tax applies to pensions in most states, but ten states do not tax pension income at all.
  • You can adjust your withholding at any time by submitting a new W-4P form to your pension administrator if you want more or less money taken out.
  • Some pensions from government jobs may have special tax rules, and you should confirm with your pension plan whether yours qualifies for any exclusions.

How withholding works and what forms you need

When your pension begins, your pension administrator sends you a Form W-4P (Withholding Certificate for Pension or Annuity Payments). This form asks you to claim allowances — a number that tells the administrator how much federal tax to take out of each payment. The more allowances you claim, the less tax is withheld. The fewer allowances you claim, the more tax is withheld.

You fill out the W-4P based on your total expected income for the year, not just your pension. If you have other income — from a job, investments, or a spouse's income — you should account for that when deciding how many allowances to claim. The IRS provides worksheets with the W-4P to help you calculate the right number.

You can change your withholding at any time by submitting a new W-4P to your pension administrator. There is no penalty for adjusting it. Many people adjust their withholding after their first tax return to correct an over-withholding or under-withholding situation.

What happens if you receive a lump-sum pension payment

Some pension plans offer the option to take your entire pension as a single lump-sum payment instead of monthly or annual payments. A lump sum is still taxable income, and the pension administrator must withhold federal income tax on it — usually 20 percent by default if you do not specify otherwise.

The 20 percent withholding is a federal requirement, not a final tax bill. Depending on your tax bracket and total income for the year, you may owe more tax or receive a refund. You will report the lump sum on your tax return for the year you receive it, which can push you into a higher tax bracket if the amount is large.

Some lump-sum payments are may be able to access for special tax treatment called forward averaging, which allows you to calculate the tax as if the payment were spread over multiple years. This can reduce your tax bill if the lump sum is very large. Ask your pension plan administrator whether your payment qualifies before you receive it.

Military and government pensions: special rules

Military pensions are taxed as ordinary income by the federal government. However, some states exempt military pensions from state income tax even if they tax other pensions. If you receive a military pension and live in one of these states, you will owe federal tax but not state tax on that income.

Government employee pensions (from federal, state, or local government jobs) are also taxed as ordinary income. However, some government employees may have contributions to their pension that were made with after-tax dollars. In those cases, a portion of each pension payment is not taxed because it represents a return of your own money. Your pension administrator will tell you what portion, if any, is non-taxable.

If you are a federal employee who participated in the Thrift Savings Plan (TSP), withdrawals from that account are taxed separately from your pension. The same rules apply: federal income tax is owed, and you can adjust withholding on a separate form.

Taxes on pension income you did not expect

If you have a pension and also work part-time or full-time, your combined income may push you into a higher tax bracket than either source alone would. The IRS taxes your total income as a whole, not each source separately. This means you might owe more in total tax than you would if you had only one income source.

Social Security benefits can also interact with pension income in ways that increase your tax bill. If your combined income (pension plus half of your Social Security benefits) exceeds certain thresholds, a portion of your Social Security becomes taxable. This is separate from the tax you owe on the pension itself.

Investment income — dividends, interest, capital gains — is also added to your total income for the year. If you have a pension and investment accounts, the combination can result in a higher tax rate on all your income. This is why it is important to look at your total income picture, not just your pension, when planning for taxes.

How to estimate what you will owe

The simplest way to estimate your tax bill is to use the IRS Tax Withholding Estimator, available on the IRS website. You enter your pension amount, any other income, filing status, and dependents, and the tool tells you whether your current withholding is likely to result in a refund or a bill at tax time.

If you find that you are under-withholding (meaning you will owe money), you can increase your withholding by submitting a new W-4P to your pension administrator. If you are over-withholding (meaning you will get a refund), you can decrease your withholding to take home more money each month, though some people prefer to over-withhold as a way to force themselves to save.

You can also work with a tax professional or accountant to review your specific situation. This is especially useful if you have multiple income sources, own a business, or have complicated investment income.

Frequently Asked Questions

Do I have to pay taxes on my entire pension, or just part of it?

You owe federal income tax on the full amount of your pension payment, with one exception: if you made after-tax contributions to your pension plan, a portion of each payment represents a return of your own money and is not taxed. Your pension administrator will calculate this non-taxable portion and tell you what it is.

What if I did not have enough tax withheld and I owe money at tax time?

You can adjust your withholding going forward by submitting a new W-4P to your pension administrator. You can also make estimated tax payments to the IRS if you want to pay the bill before tax time. If you owe a large amount, the IRS allows you to set up a payment plan.

Can I avoid paying taxes on my pension by moving to a state that does not tax pensions?

You must be a resident of a state to benefit from its tax rules. If you move to a state that does not tax pensions, you will owe no state tax on your pension income going forward. However, you will still owe federal income tax, and you must establish residency in the new state (usually by living there for at least part of the year and filing a tax return there).

Is my pension taxed differently if I take it as a monthly payment versus a lump sum?

The total tax you owe on a pension is the same whether you take it monthly or as a lump sum — it is all ordinary income. However, a lump sum may push you into a higher tax bracket for that one year, resulting in a larger tax bill that year. Monthly payments spread the income across multiple years, which can result in a lower overall tax bill.

Do I need to file a tax return if my only income is my pension?

It depends on the amount of your pension and your age. For 2024, if you are under 65 and your only income is a pension, you must file if your pension exceeds $13,850 (single) or $27,700 (married filing jointly). If you are 65 or older, the threshold is higher. Check the IRS website for the current year's thresholds, or ask your tax preparer.