Tax time can be particularly confusing when you have pension or annuity income. The Internal Revenue Service indicates that some or all of the amounts you receive from these sources can be taxable. How pensions and annuities are taxed depends on various factors. Fortunately, the IRS offers various tools for calculations.
The Taxable Portion of Your Pensions and Annuities
The IRS indicates that your payments are partially taxable if your contributions to your pension or annuity were made with after-tax dollars. You won't pay tax on the portion of the payments that represent a return of the after-tax amount you paid.
These contributions represent your cost in the plan or investment, and they include amounts that your employer might have contributed that were taxable to you as income at the time.
Any contributions you made with after-tax income and for which you never took a tax deduction aren't taxable to you at the time of distribution. You've already paid taxes on that money. This includes contributions your employer made on your behalf but which were attributed to you as income, so you paid taxes on the amounts when they were contributed.
The General Rule vs. the Simplified
You must determine the method by which the remaining amounts will be taxed. Partly taxable pensions and annuities are taxed under either the General Rule or the Simplified Method.
You must use the General Rule if your annuity or pension payments began on or before November 18, 1996. You can use the Simplified Method to calculate your taxable portion if your pension or annuity payments began after this date.
You're restricted to using the General Rule if the starting date of your annuity was between July 1, 1986 and November 18, 1996 and you don't qualify to use the Simplified Method.
You must also use the General Rule if your starting date is after November 18, 1996, you were age 75 or older as of that date, and your payments were guaranteed for at least five years.
You're limited to using the General Rule if you've received payments from a nonqualified plan. A qualified retirement plan is a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan.
The General Rule
The General Rule requires that you use the life expectancy or "actuarial" tables provided by the IRS to figure the taxable and tax-free portions of your payments. They're included in IRS Publication 939, General Rule for Pensions and Annuities, and the publication also walks you through the calculations for your taxable pension and annuity under the General Rule.
The IRS will calculate your taxable pension income under the General Rule for you for a nominal fee if you don't want to risk making a mistake.
The easiest, safest option might be to have a tax professional or the IRS make these calculations for you.
The Simplified Method
The IRS indicates that you can generally use the Simplified Method to determine how much of your annuity or pension payments are taxable and how much are tax- free if the starting date of payments was after November 18, 1996. The IRS provides a Simplified Method Worksheet to help you along.
How to Report Pension and Annuity Income
Separate any 1099-R statements you receive into two piles: those from your IRA, and those from your pension or annuity plans. You'll report your IRA distributions on line 4a of the 2020 Form 1040. Report your pension and annuity distributions on line 5a.
These lines pertain only to the 2020 Form 1040 tax return. The IRS has revised Form 1040 several times since 2017, and the appropriate lines can be different for each tax year.
NOTE: The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.