The Short Answer: It Depends on How You Funded It

Whether you pay income tax on your pension depends almost entirely on whether you or your employer paid the contributions with pre-tax or after-tax dollars. If your employer contributed money before taxes were taken out of your paycheck, that money is taxable when you withdraw it. If you contributed after-tax money yourself, that portion comes out tax-free. Most people have a mix of both, which means part of each check is taxable and part is not.

The IRS calls the after-tax portion your basis — the money you already paid tax on. The pre-tax portion is called taxable income. When you start taking pension payments, you will receive a form that tells you exactly what percentage of each payment is taxable. You do not calculate this yourself.

Key Takeaways

  • Pensions funded with pre-tax employer contributions are fully taxable; pensions funded with your own after-tax contributions are partially or fully tax-free depending on how much you contributed.
  • Your pension provider sends you a form each year showing the taxable and non-taxable portions of your payments, and you report this on your tax return.
  • If you contributed after-tax money to your pension, you must file Form 8606 with the IRS to prove it, or the IRS will tax the entire amount.
  • State income tax on pensions varies widely — some states tax all pension income, some tax none, and some have rules based on your age or when you retired.
  • Withdrawing a lump sum instead of monthly payments changes how much tax you owe in a single year and may push you into a higher tax bracket.

When Your Entire Pension Is Taxable

If your employer paid all the contributions to your pension and you contributed nothing out of your own paycheck, the entire pension is taxable income. This is the most common situation for traditional employer pensions. Every dollar you receive is subject to federal income tax at your ordinary income tax rate.

The same is true if you contributed to the pension but your contributions were made with pre-tax dollars — money taken from your paycheck before income tax was withheld. Those contributions reduced your taxable income in the year you made them, so the IRS considers the entire benefit taxable when you receive it.

When Part of Your Pension Is Tax-Free

If you contributed after-tax money to your pension — money you earned and paid income tax on before putting it into the plan — that portion is not taxed again when you withdraw it. The IRS does not tax the same dollar twice.

To claim this tax-free portion, you must have documentation showing how much after-tax money you contributed over your working years. Your pension provider may have this record, but you should also keep your own copies of pay stubs, pension statements, or contribution records. If you cannot prove you made after-tax contributions, the IRS will treat the entire pension as taxable.

The tax-free portion is calculated as a percentage of your total pension. If you contributed $50,000 after-tax and your total pension value is $200,000, roughly 25 percent of each payment will be tax-free. This percentage stays the same for the life of the pension, even if you live longer than expected and receive more total payments than the pension was originally worth.

How to Report After-Tax Contributions to the IRS

If you have after-tax contributions, you must file Form 8606 with your federal tax return in the first year you receive pension payments. This form tells the IRS about your basis — the after-tax money you already paid tax on. Without this form, the IRS assumes your entire pension is taxable.

You will need to list the total after-tax contributions you made over all your years of employment. If your pension provider does not have this information, contact your former employer's human resources or benefits department. Some employers keep records going back decades; others do not. If records are truly unavailable, you may be able to reconstruct contributions using old tax returns or W-2 forms, which sometimes show pension contributions separately.

Once you file Form 8606 and establish your basis, you do not need to file it again in future years — the IRS has the record. However, if you have multiple pensions or other retirement accounts, the rules become more complex, and you may need a tax professional to calculate the correct amount.

State Income Tax on Pensions

Federal income tax is only part of the picture. State income tax on pensions varies dramatically. Some states do not tax pension income at all. Others tax all pension income the same way the federal government does. Still others have special rules based on your age, when you retired, or how much income you have.

A few states — including Illinois, Mississippi, and Pennsylvania — do not tax pension income from public employee pensions, though they may tax private pensions differently. Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming have no state income tax at all. Other states tax pensions but offer partial exemptions for people over a certain age, usually 59½ or 62.

Check your state's tax authority website or speak with a tax professional who knows your state's rules. State tax can add 3 to 10 percent to your total tax bill, depending on where you live and how much pension income you receive.

Lump-Sum Withdrawals and Tax Brackets

If you take your entire pension as a single lump-sum payment instead of monthly installments, all that money is taxable in the year you receive it. This can push you into a much higher tax bracket than you would be in if you spread the payments over several years.

For example, if your pension is worth $300,000 and you take it all at once, you might owe 24 or 32 percent federal tax on a large portion of it. If you take $15,000 per year for 20 years, each year's payment might be taxed at 12 or 22 percent. The difference can be tens of thousands of dollars.

Some pension plans allow you to roll a lump sum into an Individual Retirement Account (IRA) instead of taking the cash. This delays the tax until you withdraw from the IRA, and it gives you more control over how much you take each year. Ask your pension provider whether a rollover is an option before you decide to take a lump sum.

Medicare Premiums and Provisional Income

Pension income affects your Medicare premiums in a way that goes beyond ordinary income tax. The IRS uses a calculation called provisional income to determine whether you pay higher Medicare Part B and Part D premiums. Provisional income includes your adjusted gross income plus half of your Social Security benefits plus all of your tax-exempt interest.

If your provisional income exceeds certain thresholds — $97,000 for single filers and $194,000 for married couples filing jointly in 2024, though these amounts change yearly — you will pay a surcharge on top of your regular Medicare premiums. Pension income counts toward this calculation, so taking a large pension payment in a single year can trigger higher Medicare costs for the following year.

This is one reason to consider spreading pension withdrawals over time rather than taking a lump sum. A tax professional can help you model different withdrawal scenarios to see which one minimizes your total tax and Medicare costs.

Frequently Asked Questions

Do I have to pay taxes on my pension if I am over 65?

Age does not change whether your pension is taxable. If your pension was funded with pre-tax money, it is taxable at any age. Some states offer tax breaks on pension income for people over a certain age, but federal tax applies regardless of how old you are.

What if I worked for a government employer — is my pension treated differently?

Government pensions follow the same tax rules as private pensions: pre-tax contributions are taxable, after-tax contributions are not. However, some states exempt government pensions from state income tax while taxing private pensions, so the rules vary by location. Check your state's tax authority for specifics.

Can I avoid taxes by taking my pension as a lump sum and putting it in an IRA?

A direct rollover from your pension to an IRA does not trigger immediate taxes — the money moves directly without you touching it. However, the money is still taxable when you withdraw it from the IRA later. You are delaying the tax, not avoiding it. If you take the lump sum as cash first, you will owe taxes immediately and may face a 10 percent early withdrawal penalty if you are under 59½.

What happens if I do not report my after-tax contributions?

If you do not file Form 8606 to document your after-tax contributions, the IRS will treat your entire pension as taxable. You can file an amended return later to correct this, but it is easier to get it right the first time. Keep all documentation of after-tax contributions and file the form in your first year of pension payments.

Does my pension count as income for other benefits like Medicaid or food assistance?

Yes. Pension income counts as income for means-tested programs like Medicaid, Supplemental Security Income (SSI), and SNAP (food assistance). The amount that counts may be the gross pension payment or the taxable portion, depending on the program. Contact your state's benefits office to learn how your specific pension is counted.