Most pensions are taxable income, but the amount you pay tax on depends on how you funded the pension and when you started withdrawing

Whether you owe tax on your pension comes down to one question: did you pay tax on the money when it went into the pension, or not? If you contributed pre-tax dollars (money taken from your paycheck before income tax was withheld), you will owe income tax on the full amount you withdraw. If you contributed after-tax dollars (money you already paid tax on), you will owe tax only on the earnings the pension generated, not on your original contributions.

The IRS treats different types of pensions differently. A traditional pension or 401(k) funded with pre-tax contributions is fully taxable. A Roth 401(k) or Roth IRA funded with after-tax contributions is not taxable on withdrawal, as long as you meet the age and holding-period rules. A regular IRA can be either, depending on whether you deducted your contributions when you filed taxes.

You will receive a form each year showing how much of your pension withdrawal is taxable. For traditional pensions, your employer sends a 1099-R. For IRAs, the custodian sends a 1099-R. The form tells you the gross distribution, any taxes already withheld, and the taxable amount. You report this on your tax return.

Key Takeaways

  • Traditional pensions and 401(k)s funded with pre-tax money are fully taxable as ordinary income when you withdraw them.
  • Roth accounts funded with after-tax money are not taxable on withdrawal if you are at least 59½ and the account has been open for at least five years.
  • Your employer or account custodian will send you a 1099-R form each year showing how much of your withdrawal is taxable.
  • Pension income counts as income for tax purposes and may affect whether you owe tax on Social Security benefits or lose other tax deductions.
  • Some states do not tax pension income at all, while others tax it fully; your state of residence determines this.

How traditional pensions are taxed

A traditional pension — whether from an employer, a 401(k), or a traditional IRA — is taxed as ordinary income. This means the money you withdraw is added to your other income (wages, interest, Social Security) and taxed at your marginal tax rate. If you withdraw $30,000 from a traditional pension in a year when your other income is $50,000, you report $80,000 in total income and pay tax on all of it at the rates that apply to that bracket.

The reason is simple: when the money went into the pension, you did not pay income tax on it. Your employer deducted it from your paycheck before calculating what you owed, or you deducted it on your tax return. The government deferred that tax, not forgave it. When you withdraw the money, the deferral ends and the tax is due.

If your employer withheld taxes from your pension checks, that amount is subtracted from what you owe when you file your return — but you still owe tax on the full taxable amount. Withholding is just a prepayment. If too little was withheld, you will owe more when you file. If too much was withheld, you will receive a refund.

How Roth accounts are taxed

A Roth 401(k) or Roth IRA works the opposite way. You fund it with after-tax dollars — money you already paid income tax on. When you withdraw the money, you owe no tax on the contributions or the earnings, as long as you meet two conditions: you must be at least 59½ years old, and the account must have been open for at least five years.

If you withdraw money before 59½, or before the five-year holding period ends, the earnings portion becomes taxable and you may owe a 10 percent early withdrawal penalty. The contributions themselves can always be withdrawn tax-free, but the growth on those contributions is subject to tax and penalty if you do not meet the age and time requirements.

The five-year rule applies to the account as a whole, not to each contribution. If you opened a Roth IRA in 2015 and made your first contribution then, all Roth withdrawals after 2020 are tax-free (assuming you are 59½). If you opened a second Roth IRA in 2020, you cannot withdraw earnings tax-free from that account until 2025, even though you may have already satisfied the rule for your first account.

How mixed contributions are taxed

Some people have both pre-tax and after-tax money in the same type of account — for example, a traditional IRA that holds both deductible contributions (pre-tax) and non-deductible contributions (after-tax). The IRS uses a formula called the pro-rata rule to determine how much of each withdrawal is taxable.

The pro-rata rule works like this: add up all your traditional IRAs (not 401(k)s — they are treated separately). Calculate what percentage of the total is after-tax contributions. That same percentage of every withdrawal is tax-free; the rest is taxable. If your traditional IRAs hold $100,000 total, and $20,000 of that is after-tax contributions, then 20 percent of every withdrawal is tax-free and 80 percent is taxable, no matter which account the money came from.

This rule can create a tax trap for people who want to convert a traditional IRA to a Roth. If you have $100,000 in a traditional IRA and want to convert $50,000 to a Roth, the pro-rata rule means that only $10,000 of the conversion is your after-tax contributions (tax-free); the other $40,000 is pre-tax money and is taxable in the year you convert. Many people are surprised by this and end up owing more tax than they expected.

How pension income affects other taxes

Pension withdrawals count as income for purposes of other tax rules, which can increase your total tax bill in ways that are not obvious. The most common trap is Social Security taxation. If your pension income plus half your Social Security benefits plus other income exceeds certain thresholds ($25,000 for single filers, $32,000 for married filing jointly), you will owe tax on up to 85 percent of your Social Security benefits. This is separate from the tax on the pension itself.

Pension income can also reduce or eliminate tax deductions you might otherwise claim. If your modified adjusted gross income is too high, you cannot deduct IRA contributions, you lose the child tax credit, and you cannot claim the saver's credit. Pension withdrawals push your income higher, which can trigger these phase-outs.

Some tax credits and deductions have income limits that pension income counts toward. The earned income tax credit, the education credits, and the retirement savings contribution credit all phase out as income rises. If you are close to a phase-out threshold, a large pension withdrawal can cost you more in lost credits than you gain in the withdrawal itself.

State tax treatment of pensions

Some states tax pension income fully, some tax it partially, and some do not tax it at all. Your state of residence determines this, not the state where you worked or where the pension is paid from.

States that do not tax pension income include Florida, Illinois, Mississippi, Pennsylvania, and Tennessee. Some of these states have restrictions — for example, Illinois exempts pensions from public employees and the military, but not private pensions. Pennsylvania exempts pensions but not IRAs or 401(k)s. You need to check your specific state's rules.

States that tax pensions fully include California, New York, and most others. A few states tax only part of pension income — for example, some states exempt the first $15,000 or $20,000 of pension income per person. If you are considering moving in retirement, state tax treatment of pensions can make a significant difference in your after-tax income.

What form you receive and how to report it

Your pension provider sends you a Form 1099-R each year you take a distribution. The form shows the gross amount distributed, any federal income tax withheld, the taxable amount, and a code describing the type of distribution. You receive Copy B for your records and Copy A goes to the IRS.

You report the taxable amount from the 1099-R on your tax return. For most people, this goes on Form 1040, line 5a (for IRAs, pensions, and annuities). If you received a lump-sum distribution from a pension and chose to use special averaging or capital gains treatment (an older rule that still applies to some distributions), you may need to file Form 4972 instead of reporting the amount directly on Form 1040.

If you received distributions from multiple pensions or IRAs, you receive multiple 1099-Rs. You add up all the taxable amounts and report the total. If tax was withheld from some distributions but not others, you add up all the withholding and claim it as a payment toward your total tax liability.

Frequently Asked Questions

Do I have to pay tax on my pension if I do not need the money?

Yes. Once you start withdrawing from a traditional pension, the withdrawals are taxable income whether you spend the money or not. If you do not need the money, you can reinvest it, but you still owe tax on it in the year you withdraw it. The only way to avoid this is to not withdraw the money — but most pensions require you to start withdrawals at age 73 (as of 2023) under the required minimum distribution rules.

What if I withdraw my pension before age 59½?

You will owe income tax on the taxable amount, plus a 10 percent early withdrawal penalty on top of that. Some exceptions exist — you can withdraw penalty-free if you are disabled, if you use the money for medical expenses over 7.5 percent of your income, or if you take substantially equal periodic payments. But the income tax is still due. The penalty is separate and adds 10 percent to your tax bill.

Can I avoid paying tax by rolling my pension into an IRA?

A rollover does not trigger tax — you move the money from one account to another without withdrawing it. But once you withdraw from the IRA, you owe the same tax you would have owed on the original pension. A rollover just delays the tax and gives you more control over when and how much you withdraw. It does not eliminate the tax.

Is my pension taxed differently if I am retired versus still working?

No. The tax on your pension depends on whether it is pre-tax or after-tax money, not on your employment status. If you are still working and drawing a pension at the same time, your pension income is added to your wages, and you pay tax on the total at your marginal rate. This can push you into a higher tax bracket.

Do I have to report my pension on my tax return if tax was already withheld?

Yes. Withholding is not the same as paying tax. You must report the full taxable amount on your return. The withholding is credited against what you owe, but if it was not enough, you will owe more when you file. If it was too much, you will receive a refund.