10.   Retirement Plans, Pensions, and Annuities

What's New

For purposes of the Net Investment Income Tax (NIIT), net investment income does not include distributions from a qualified retirement plan (for example, 401(a), 403(a), 403(b), 408, 408A, or 457(b) plans). However, these distributions are taken into account when determining the modified adjusted gross income threshold. Distributions from a nonqualified retirement plan are included in net investment income. See Form 8960, Net Investment Income Tax - Individuals, Estates, and Trusts, and its instructions for more information.

Reminder

Starting in 2013, the American Taxpayer Relief Act of 2012 expanded the rules for in-plan Roth rollovers to include more taxpayers. For more information, see Designated Roth accounts discussed later.

Introduction

This chapter discusses the tax treatment of distributions you receive from:

  • An employee pension or annuity from a qualified plan,

  • A disability retirement, and

  • A purchased commercial annuity.

What is not covered in this chapter.   The following topics are not discussed in this chapter.

The General Rule.   This is the method generally used to determine the tax treatment of pension and annuity income from nonqualified plans (including commercial annuities). For a qualified plan, you generally cannot use the General Rule unless your annuity starting date is before November 19, 1996. For more information about the General Rule, see Publication 939, General Rule for Pensions and Annuities.

Individual retirement arrangements (IRAs).   Information on the tax treatment of amounts you receive from an IRA is in chapter 17.

Civil service retirement benefits.    If you are retired from the federal government (regular, phased, or disability retirement), see Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits. Publication 721 also covers the information that you need if you are the survivor or beneficiary of a federal employee or retiree who died.

Useful Items - You may want to see:

Publication

  • 575 Pension and Annuity Income

  • 721 Tax Guide to U.S. Civil Service Retirement Benefits

  • 939 General Rule for Pensions and Annuities

Form (and Instructions)

  • W-4P Withholding Certificate for Pension or Annuity Payments

  • 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

  • 4972 Tax on Lump-Sum Distributions

  • 5329 Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts

General Information

Designated Roth accounts.   A designated Roth account is a separate account created under a qualified Roth contribution program to which participants may elect to have part or all of their elective deferrals to a 401(k), 403(b), or 457(b) plan designated as Roth contributions. Elective deferrals that are designated as Roth contributions are included in your income. However, qualified distributions are not included in your income. See Publication 575 for more information.

In-plan rollovers to designated Roth accounts.   If you are a participant in a 401(k), 403(b), or 457(b) plan, your plan may permit you to roll over amounts in those plans to a designated Roth account within the same plan. The rollover of any untaxed amounts must be included in income. See Publication 575 for more information.

More than one program.   If you receive benefits from more than one program under a single trust or plan of your employer, such as a pension plan and a profit-sharing plan, you may have to figure the taxable part of each pension or annuity contract separately. Your former employer or the plan administrator should be able to tell you if you have more than one pension or annuity contract.

Section 457 deferred compensation plans.    If you work for a state or local government or for a tax-exempt organization, you may be able to participate in a section 457 deferred compensation plan. If your plan is an eligible plan, you are not taxed currently on pay that is deferred under the plan or on any earnings from the plan's investment of the deferred pay. You are generally taxed on amounts deferred in an eligible state or local government plan only when they are distributed from the plan. You are taxed on amounts deferred in an eligible tax-exempt organization plan when they are distributed or otherwise made available to you.

  Your 457(b) plan may have a designated Roth account option. If so, you may be able to roll over amounts to the designated Roth account or make contributions. Elective deferrals to a designated Roth account are included in your income. Qualified distributions from a designated Roth account are not subject to tax.

  This chapter covers the tax treatment of benefits under eligible section 457 plans, but it does not cover the treatment of deferrals. For information on deferrals under section 457 plans, see Retirement Plan Contributions under Employee Compensation in Publication 525, Taxable and Nontaxable Income.

  For general information on these deferred compensation plans, see Section 457 Deferred Compensation Plans in Publication 575.

Disability pensions.   If you retired on disability, you generally must include in income any disability pension you receive under a plan that is paid for by your employer. You must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A until you reach minimum retirement age. Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled.

  
You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on the credit for the elderly or the disabled, see chapter 33.

  Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Report the payments on Form 1040, lines 16a and 16b, or on Form 1040A, lines 12a and 12b.

  
Disability payments for injuries incurred as a direct result of a terrorist attack directed against the United States (or its allies) are not included in income. For more information about payments to survivors of terrorist attacks, see Publication 3920, Tax Relief for Victims of Terrorist Attacks.

  For more information on how to report disability pensions, including military and certain government disability pensions, see chapter 5.

Retired public safety officers.   An eligible retired public safety officer can elect to exclude from income distributions of up to $3,000 made directly from a government retirement plan to the provider of accident, health, or long-term disability insurance. See Insurance Premiums for Retired Public Safety Officers in Publication 575 for more information.

Railroad retirement benefits.   Part of any railroad retirement benefits you receive is treated for tax purposes as social security benefits, and part is treated as an employee pension. For information about railroad retirement benefits treated as social security benefits, see Publication 915, Social Security and Equivalent Railroad Retirement Benefits. For information about railroad retirement benefits treated as an employee pension, see Railroad Retirement Benefits in Publication 575.

Withholding and estimated tax.   The payer of your pension, profit-sharing, stock bonus, annuity, or deferred compensation plan will withhold income tax on the taxable parts of amounts paid to you. You can tell the payer how much to withhold, or not to withhold, by filing Form W-4P. If you choose not to have tax withheld, or you do not have enough tax withheld, you may have to pay estimated tax.

  If you receive an eligible rollover distribution, you cannot choose not to have tax withheld. Generally, 20% will be withheld, but no tax will be withheld on a direct rollover of an eligible rollover distribution. See Direct rollover option under Rollovers, later.

  For more information, see Pensions and Annuities under Tax Withholding for 2014 in chapter 4.

Qualified plans for self-employed individuals.   Qualified plans set up by self-employed individuals are sometimes called Keogh or H.R. 10 plans. Qualified plans can be set up by sole proprietors, partnerships (but not a partner), and corporations. They can cover self-employed persons, such as the sole proprietor or partners, as well as regular (common-law) employees.

   Distributions from a qualified plan are usually fully taxable because most recipients have no cost basis. If you have an investment (cost) in the plan, however, your pension or annuity payments from a qualified plan are taxed under the Simplified Method. For more information about qualified plans, see Publication 560, Retirement Plans for Small Business.

Purchased annuities.   If you receive pension or annuity payments from a privately purchased annuity contract from a commercial organization, such as an insurance company, you generally must use the General Rule to figure the tax-free part of each annuity payment. For more information about the General Rule, get Publication 939. Also, see Variable Annuities in Publication 575 for the special provisions that apply to these annuity contracts.

Loans.   If you borrow money from your retirement plan, you must treat the loan as a nonperiodic distribution from the plan unless certain exceptions apply. This treatment also applies to any loan under a contract purchased under your retirement plan, and to the value of any part of your interest in the plan or contract that you pledge or assign. This means that you must include in income all or part of the amount borrowed. Even if you do not have to treat the loan as a nonperiodic distribution, you may not be able to deduct the interest on the loan in some situations. For details, see Loans Treated as Distributions in Publication 575. For information on the deductibility of interest, see chapter 23.

Tax-free exchange.   No gain or loss is recognized on an exchange of an annuity contract for another annuity contract if the insured or annuitant remains the same. However, if an annuity contract is exchanged for a life insurance or endowment contract, any gain due to interest accumulated on the contract is ordinary income. See Transfers of Annuity Contracts in Publication 575 for more information about exchanges of annuity contracts.

How To Report

If you file Form 1040, report your total annuity on line 16a and the taxable part on line 16b. If your pension or annuity is fully taxable, enter it on line 16b; do not make an entry on line 16a.

If you file Form 1040A, report your total annuity on line 12a and the taxable part on line 12b. If your pension or annuity is fully taxable, enter it on line 12b; do not make an entry on line 12a.

More than one annuity.   If you receive more than one annuity and at least one of them is not fully taxable, enter the total amount received from all annuities on Form 1040, line 16a, or Form 1040A, line 12a, and enter the taxable part on Form 1040, line 16b, or Form 1040A, line 12b. If all the annuities you receive are fully taxable, enter the total of all of them on Form 1040, line 16b, or Form 1040A, line 12b.

Joint return.   If you file a joint return and you and your spouse each receive one or more pensions or annuities, report the total of the pensions and annuities on Form 1040, line 16a, or Form 1040A, line 12a, and report the taxable part on Form 1040, line 16b, or Form 1040A, line 12b.

Cost (Investment in the Contract)

Before you can figure how much, if any, of a distribution from your pension or annuity plan is taxable, you must determine your cost (your investment in the contract) in the pension or annuity. Your total cost in the plan includes the total premiums, contributions, or other amounts you paid. This includes the amounts your employer contributed that were taxable to you when paid. Cost does not include any amounts you deducted or were excluded from your income.

From this total cost, subtract any refunds of premiums, rebates, dividends, unrepaid loans that were not included in your income, or other tax-free amounts that you received by the later of the annuity starting date or the date on which you received your first payment.

Your annuity starting date is the later of the first day of the first period for which you received a payment or the date the plan's obligations became fixed.

Designated Roth accounts.   Your cost in these accounts is your designated Roth contributions that were included in your income as wages subject to applicable withholding requirements. Your cost will also include any in-plan Roth rollovers you included in income.

Foreign employment contributions.   If you worked in a foreign country and contributions were made to your retirement plan, special rules apply in determining your cost. See Foreign employment contributions under Cost (Investment in the Contract) in Publication 575.

Taxation of Periodic Payments

Fully taxable payments.   Generally, if you did not pay any part of the cost of your employee pension or annuity and your employer did not withhold part of the cost from your pay while you worked, the amounts you receive each year are fully taxable. You must report them on your income tax return.

Partly taxable payments.   If you paid part of the cost of your pension or annuity, you are not taxed on the part of the pension or annuity you receive that represents a return of your cost. The rest of the amount you receive is generally taxable. You figure the tax-free part of the payment using either the Simplified Method or the General Rule. Your annuity starting date and whether or not your plan is qualified determine which method you must or may use.

  If your annuity starting date is after November 18, 1996, and your payments are from a qualified plan, you must use the Simplified Method. Generally, you must use the General Rule if your annuity is paid under a nonqualified plan, and you cannot use this method if your annuity is paid under a qualified plan.

  If you had more than one partly taxable pension or annuity, figure the tax-free part and the taxable part of each separately.

  If your annuity is paid under a qualified plan and your annuity starting date is after July 1, 1986, and before November 19, 1996, you could have chosen to use either the General Rule or the Simplified Method.

Exclusion limit.   Your annuity starting date determines the total amount of annuity payments that you can exclude from your taxable income over the years. Once your annuity starting date is determined, it does not change. If you calculate the taxable portion of your annuity payments using the simplified method worksheet, the annuity starting date determines the recovery period for your cost. That recovery period begins on your annuity starting date and is not affected by the date you first complete the worksheet.

Exclusion limited to cost.   If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a recovery of the cost cannot exceed your total cost. Any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. This deduction is not subject to the 2%-of-adjusted-gross-income limit.

Exclusion not limited to cost.   If your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. If you chose a joint and survivor annuity, your survivor can continue to take the survivor's exclusion figured as of the annuity starting date. The total exclusion may be more than your cost.

Simplified Method

Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly payments. For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. For any other annuity, this number is the number of monthly annuity payments under the contract.

Who must use the Simplified Method.   You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you both:
  1. Receive pension or annuity payments from a qualified employee plan, qualified employee annuity, or a tax-sheltered annuity (403(b)) plan, and

  2. On your annuity starting date, you were either under age 75, or entitled to less than 5 years of guaranteed payments.

Guaranteed payments.   Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment) is payable even if you and any survivor annuitant do not live to receive the minimum. If the minimum amount is less than the total amount of the payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are entitled to less than 5 years of guaranteed payments.

How to use the Simplified Method.    Complete the Simplified Method Worksheet in Publication 575 to figure your taxable annuity for 2013.

Single-life annuity.    If your annuity is payable for your life alone, use Table 1 at the bottom of the worksheet to determine the total number of expected monthly payments. Enter on line 3 the number shown for your age at the annuity starting date.

Multiple-lives annuity.   If your annuity is payable for the lives of more than one annuitant, use Table 2 at the bottom of the worksheet to determine the total number of expected monthly payments. Enter on line 3 the number shown for the combined ages of you and the youngest survivor annuitant at the annuity starting date.

  However, if your annuity starting date is before 1998, do not use Table 2 and do not combine the annuitants' ages. Instead you must use Table 1 and enter on line 3 the number shown for the primary annuitant's age on the annuity starting date.

  
Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity next year.

Example.

Bill Smith, age 65, began receiving retirement benefits in 2013, under a joint and survivor annuity. Bill's annuity starting date is January 1, 2013. The benefits are to be paid for the joint lives of Bill and his wife Kathy, age 65. Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Bill's death.

Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. Because his annuity is payable over the lives of more than one annuitant, he uses his and Kathy's combined ages and Table 2 at the bottom of the worksheet in completing line 3 of the worksheet. His completed worksheet is shown in Worksheet 10-A.

Bill's tax-free monthly amount is $100 ($31,000 ÷ 310) as shown on line 4 of the worksheet. Upon Bill's death, if Bill has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. The full amount of any annuity payments received after 310 payments are paid must be included in gross income.

If Bill and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. This deduction is not subject to the 2%-of-adjusted- gross-income limit.

Worksheet 10-A. Simplified Method Worksheet for Bill Smith

1. Enter the total pension or annuity payments received this year. Also, add this amount to the total for Form 1040, line 16a, or Form 1040A, line 12a 1. 14,400
2. Enter your cost in the plan (contract) at the annuity starting date plus any death benefit exclusion*. See Cost (Investment in the Contract) , earlier 2. 31,000    
  Note: If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below (even if the amount of your pension or annuity has changed). Otherwise, go to line 3.        
3. Enter the appropriate number from Table 1 below. But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below 3. 310    
4. Divide line 2 by the number on line 3 4. 100    
5. Multiply line 4 by the number of months for which this year's payments were made. If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. Otherwise, go to line 6 5. 1,200    
6. Enter any amounts previously recovered tax free in years after 1986. This is the amount shown on line 10 of your worksheet for last year 6. -0-    
7. Subtract line 6 from line 2 7. 31,000    
8. Enter the smaller of line 5 or line 7 8. 1,200
9. Taxable amount for year. Subtract line 8 from line 1. Enter the result, but not less than zero. Also, add this amount to the total for Form 1040, line 16b, or Form 1040A, line 12b 9. 13,200
  Note: If your Form 1099-R shows a larger taxable amount, use the amount figured on this line instead. If you are a retired public safety officer, see Insurance Premiums for Retired Public Safety Officers in Publication 575 before entering an amount on your tax return.    
10. Was your annuity starting date before 1987? 
□ Yes. STOP. Do not complete the rest of this worksheet. 
☑ No. Add lines 6 and 8. This is the amount you have recovered tax free through 2013. You will need this number if you need to fill out this worksheet next year
10. 1,200
11. Balance of cost to be recovered. Subtract line 10 from line 2. If zero, you will not have to complete this worksheet next year. The payments you receive next year will generally be fully taxable 11. 29,800
TABLE 1 FOR LINE 3 ABOVE
  AND your annuity starting date was—
IF the age at annuity 
starting date was...
before November 19, 
1996, enter on line 3...
after November 18, 
1996, enter on line 3...
55 or under 300 360
56–60 260 310
61–65 240 260
66–70 170 210
71 or older 120 160
TABLE 2 FOR LINE 3 ABOVE
IF the combined ages 
at annuity starting 
date were...
  THEN enter 
on line 3...
110 or under   410
111–120   360
121–130   310
131–140   260
141 or older   210

* A death benefit exclusion (up to $5,000) applied to certain benefits received by employees who died before August 21, 1996.

Who must use the General Rule.   You must use the General Rule if you receive pension or annuity payments from:
  • A nonqualified plan (such as a private annuity, a purchased commercial annuity, or a nonqualified employee plan), or

  • A qualified plan if you are age 75 or older on your annuity starting date and your annuity payments are guaranteed for at least 5 years.

Annuity starting before November 19, 1996.   If your annuity starting date is after July 1, 1986, and before November 19, 1996, you had to use the General Rule for either circumstance just described. You also had to use it for any fixed-period annuity. If you did not have to use the General Rule, you could have chosen to use it. If your annuity starting date is before July 2, 1986, you had to use the General Rule unless you could use the Three-Year Rule.

  If you had to use the General Rule (or chose to use it), you must continue to use it each year that you recover your cost.

Who cannot use the General Rule.   You cannot use the General Rule if you receive your pension or annuity from a qualified plan and none of the circumstances described in the preceding discussions apply to you. See Who must use the Simplified Method , earlier.

More information.   For complete information on using the General Rule, including the actuarial tables you need, see Publication 939.

Taxation of Nonperiodic Payments

Nonperiodic distributions are also known as amounts not received as an annuity. They include all payments other than periodic payments and corrective distributions. Examples of nonperiodic payments are cash withdrawals, distributions of current earnings, certain loans, and the value of annuity contracts transferred without full and adequate consideration.

Corrective distributions of excess plan contributions.   Generally, if the contributions made for you during the year to certain retirement plans exceed certain limits, the excess is taxable to you. To correct an excess, your plan may distribute it to you (along with any income earned on the excess). For information on plan contribution limits and how to report corrective distributions of excess contributions, see Retirement Plan Contributions under Employee Compensation in Publication 525.

Figuring the taxable amount of nonperiodic payments.   How you figure the taxable amount of a nonperiodic distribution depends on whether it is made before the annuity starting date, or on or after the annuity starting date. If it is made before the annuity starting date, its tax treatment also depends on whether it is made under a qualified or nonqualified plan. If it is made under a nonqualified plan, its tax treatment depends on whether it fully discharges the contract, is received under certain life insurance or endowment contracts, or is allocable to an investment you made before August 14, 1982.

Annuity starting date.   The annuity starting date is either the first day of the first period for which you receive an annuity payment under the contract or the date on which the obligation under the contract becomes fixed, whichever is later.

Distribution on or after annuity starting date.   If you receive a nonperiodic payment from your annuity contract on or after the annuity starting date, you generally must include all of the payment in gross income.

Distribution before annuity starting date.   If you receive a nonperiodic distribution before the annuity starting date from a qualified retirement plan, you generally can allocate only part of it to the cost of the contract. You exclude from your gross income the part that you allocate to the cost. You include the remainder in your gross income.

  If you receive a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan (nonqualified plan), it is allocated first to earnings (the taxable part) and then to the cost of the contract (the tax-free part). This allocation rule applies, for example, to a commercial annuity contract you bought directly from the issuer.

  
Distributions from nonqualified plans are subject to the net investment income tax. See the Instructions for Form 8960.

  For more information, see Figuring the Taxable Amount under Taxation of Nonperiodic Payments in Publication 575.

Lump-Sum Distributions

This section on lump-sum distributions only applies if the plan participant was born before January 2, 1936. If the plan participant was born after January 1, 1936, the taxable amount of this nonperiodic payment is reported as discussed earlier.

A lump-sum distribution is the distribution or payment in one tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans). A distribution from a nonqualified plan (such as a privately purchased commercial annuity or a section 457 deferred compensation plan of a state or local government or tax-exempt organization) cannot qualify as a lump-sum distribution.

The participant's entire balance from a plan does not include certain forfeited amounts. It also does not include any deductible voluntary employee contributions allowed by the plan after 1981 and before 1987. For more information about distributions that do not qualify as lump-sum distributions, see Distributions that do not qualify under Lump-Sum Distributions in Publication 575.

If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974 that you do not report as capital gain) is ordinary income. You may be able to use the 10-year tax option, discussed later, to figure tax on the ordinary income part.

Use Form 4972 to figure the separate tax on a lump-sum distribution using the optional methods. The tax figured on Form 4972 is added to the regular tax figured on your other income. This may result in a smaller tax than you would pay by including the taxable amount of the distribution as ordinary income in figuring your regular tax.

How to treat the distribution.   If you receive a lump-sum distribution, you may have the following options for how you treat the taxable part.
  • Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and the part from participation after 1973 as ordinary income.

  • Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and use the 10-year tax option to figure the tax on the part from participation after 1973 (if you qualify).

  • Use the 10-year tax option to figure the tax on the total taxable amount (if you qualify).

  • Roll over all or part of the distribution. See Rollovers , later. No tax is currently due on the part rolled over. Report any part not rolled over as ordinary income.

  • Report the entire taxable part of the distribution as ordinary income on your tax return.

  The first three options are explained in the following discussions.

Electing optional lump-sum treatment.   You can choose to use the 10-year tax option or capital gain treatment only once after 1986 for any plan participant. If you make this choice, you cannot use either of these optional treatments for any future distributions for the participant.

Taxable and tax-free parts of the distribution.    The taxable part of a lump-sum distribution is the employer's contributions and income earned on your account. You may recover your cost in the lump sum and any net unrealized appreciation (NUA) in employer securities tax free.

Cost.   In general, your cost is the total of:
  • The plan participant's nondeductible contributions to the plan,

  • The plan participant's taxable costs of any life insurance contract distributed,

  • Any employer contributions that were taxable to the plan participant, and

  • Repayments of any loans that were taxable to the plan participant.

You must reduce this cost by amounts previously distributed tax free.

Net unrealized appreciation (NUA).   The NUA in employer securities (box 6 of Form 1099-R) received as part of a lump-sum distribution is generally tax free until you sell or exchange the securities. (For more information, see Distributions of employer securities under Taxation of Nonperiodic Payments in Publication 575.)

Capital Gain Treatment

Capital gain treatment applies only to the taxable part of a lump-sum distribution resulting from participation in the plan before 1974. The amount treated as capital gain is taxed at a 20% rate. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.

Complete Part II of Form 4972 to choose the 20% capital gain election. For more information, see Capital Gain Treatment under Lump-Sum Distributions in Publication 575.

10-Year Tax Option

The 10-year tax option is a special formula used to figure a separate tax on the ordinary income part of a lump-sum distribution. You pay the tax only once, for the year in which you receive the distribution, not over the next 10 years. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.

The ordinary income part of the distribution is the amount shown in box 2a of the Form 1099-R given to you by the payer, minus the amount, if any, shown in box 3. You also can treat the capital gain part of the distribution (box 3 of Form 1099-R) as ordinary income for the 10-year tax option if you do not choose capital gain treatment for that part.

Complete Part III of Form 4972 to choose the 10-year tax option. You must use the special Tax Rate Schedule shown in the instructions for Part III to figure the tax. Publication 575 illustrates how to complete Form 4972 to figure the separate tax.

Rollovers

If you withdraw cash or other assets from a qualified retirement plan in an eligible rollover distribution, you can defer tax on the distribution by rolling it over to another qualified retirement plan or a traditional IRA.

For this purpose, the following plans are qualified retirement plans.

  • A qualified employee plan.

  • A qualified employee annuity.

  • A tax-sheltered annuity plan (403(b) plan).

  • An eligible state or local government section 457 deferred compensation plan.

Eligible rollover distributions.   Generally, an eligible rollover distribution is any distribution of all or any part of the balance to your credit in a qualified retirement plan. For information about exceptions to eligible rollover distributions, see Publication 575.

Rollover of nontaxable amounts.   You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another qualified retirement plan that is a qualified employee plan or a 403(b) plan, or to a traditional or Roth IRA. The transfer must be made either through a direct rollover to a qualified plan or 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover or through a rollover to a traditional or Roth IRA.

  If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution.

  Any after-tax contributions that you roll over into your traditional IRA become part of your basis (cost) in your IRAs. To recover your basis when you take distributions from your IRA, you must complete Form 8606 for the year of the distribution. For more information, see the Form 8606 instructions.

Direct rollover option.   You can choose to have any part or all of an eligible rollover distribution paid directly to another qualified retirement plan that accepts rollover distributions or to a traditional or Roth IRA. If you choose the direct rollover option, or have an automatic rollover, no tax will be withheld from any part of the distribution that is directly paid to the trustee of the other plan.

Payment to you option.   If an eligible rollover distribution is paid to you, 20% generally will be withheld for income tax. However, the full amount is treated as distributed to you even though you actually receive only 80%. You generally must include in income any part (including the part withheld) that you do not roll over within 60 days to another qualified retirement plan or to a traditional or Roth IRA. (See Pensions and Annuities under Tax Withholding for 2014 in chapter 4.)

  
If you decide to roll over an amount equal to the distribution before withholding, your contribution to the new plan or IRA must include other money (for example, from savings or amounts borrowed) to replace the amount withheld.

Time for making rollover.   You generally must complete the rollover of an eligible rollover distribution paid to you by the 60th day following the day on which you receive the distribution from your employer's plan. (If an amount distributed to you becomes a frozen deposit in a financial institution during the 60-day period after you receive it, the rollover period is extended for the period during which the distribution is in a frozen deposit in a financial institution.)

  The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control.

  The administrator of a qualified plan must give you a written explanation of your distribution options within a reasonable period of time before making an eligible rollover distribution.

Qualified domestic relations order (QDRO).   You may be able to roll over tax free all or part of a distribution from a qualified retirement plan that you receive under a QDRO. If you receive the distribution as an employee's spouse or former spouse (not as a nonspousal beneficiary), the rollover rules apply to you as if you were the employee. You can roll over the distribution from the plan into a traditional IRA or to another eligible retirement plan. See Rollovers in Publication 575 for more information on benefits received under a QDRO.

Rollover by surviving spouse.   You may be able to roll over tax free all or part of a distribution from a qualified retirement plan you receive as the surviving spouse of a deceased employee. The rollover rules apply to you as if you were the employee. You can roll over a distribution into a qualified retirement plan or a traditional or Roth IRA. For a rollover to a Roth IRA, see Rollovers to Roth IRAs , later.

   A distribution paid to a beneficiary other than the employee's surviving spouse is generally not an eligible rollover distribution. However, see Rollovers by nonspouse beneficiary next.

Rollovers by nonspouse beneficiary.   If you are a designated beneficiary (other than a surviving spouse) of a deceased employee, you may be able to roll over tax free all or a portion of a distribution you receive from an eligible retirement plan of the employee. The distribution must be a direct trustee-to-trustee transfer to your traditional or Roth IRA that was set up to receive the distribution. The transfer will be treated as an eligible rollover distribution and the receiving plan will be treated as an inherited IRA. For information on inherited IRAs, see What if You Inherit an IRA? in chapter 1 of Publication 590, Individual Retirement Arrangements (IRAs).

Retirement bonds.   If you redeem retirement bonds purchased under a qualified bond purchase plan, you can roll over the proceeds that exceed your basis tax free into an IRA (as discussed in Publication 590) or a qualified employer plan.

Designated Roth accounts.   You can roll over an eligible rollover distribution from a designated Roth account into another designated Roth account or a Roth IRA. If you want to roll over the part of the distribution that is not included in income, you must make a direct rollover of the entire distribution or you can roll over the entire amount (or any portion) to a Roth IRA. For more information on rollovers from designated Roth accounts, see Rollovers in Publication 575.

In-plan rollovers to designated Roth accounts.   If you are a plan participant in a 401(k), 403(b), or 457(b) plan, your plan may permit you to roll over amounts in those plans to a designated Roth account within the same plan. The rollover of any untaxed amounts must be included in income. See Designated Roth accounts under Rollovers in Publication 575 for more information.

Rollovers to Roth IRAs.   You can roll over distributions directly from a qualified retirement plan (other than a designated Roth account) to a Roth IRA.

  You must include in your gross income distributions from a qualified retirement plan (other than a designated Roth account) that you would have had to include in income if you had not rolled them over into a Roth IRA. You do not include in gross income any part of a distribution from a qualified retirement plan that is a return of contributions to the plan that were taxable to you when paid. In addition, the 10% tax on early distributions does not apply.

More information.   For more information on the rules for rolling over distributions, see Rollovers in Publication 575.

Special Additional Taxes

To discourage the use of pension funds for purposes other than normal retirement, the law imposes additional taxes on early distributions of those funds and on failures to withdraw the funds timely. Ordinarily, you will not be subject to these taxes if you roll over all early distributions you receive, as explained earlier, and begin drawing out the funds at a normal retirement age, in reasonable amounts over your life expectancy. These special additional taxes are the taxes on:

  • Early distributions, and

  • Excess accumulation (not receiving minimum distributions).

These taxes are discussed in the following sections.

If you must pay either of these taxes, report them on Form 5329. However, you do not have to file Form 5329 if you owe only the tax on early distributions and your Form 1099-R correctly shows a “1” in box 7. Instead, enter 10% of the taxable part of the distribution on Form 1040, line 58 and write “No” under the heading “Other Taxes” to the left of line 58.

Even if you do not owe any of these taxes, you may have to complete Form 5329 and attach it to your Form 1040. This applies if you meet an exception to the tax on early distributions but box 7 of your Form 1099-R does not indicate an exception.

Tax on Early Distributions

Most distributions (both periodic and nonperiodic) from qualified retirement plans and nonqualified annuity contracts made to you before you reach age 59½ are subject to an additional tax of 10%. This tax applies to the part of the distribution that you must include in gross income.

For this purpose, a qualified retirement plan is:

  • A qualified employee plan,

  • A qualified employee annuity plan,

  • A tax-sheltered annuity plan, or

  • An eligible state or local government section 457 deferred compensation plan (to the extent that any distribution is attributable to amounts the plan received in a direct transfer or rollover from one of the other plans listed here or an IRA).

5% rate on certain early distributions from deferred annuity contracts.   If an early withdrawal from a deferred annuity is otherwise subject to the 10% additional tax, a 5% rate may apply instead. A 5% rate applies to distributions under a written election providing a specific schedule for the distribution of your interest in the contract if, as of March 1, 1986, you had begun receiving payments under the election. On line 4 of Form 5329, multiply the line 3 amount by 5% instead of 10%. Attach an explanation to your return.

Distributions from Roth IRAs allocable to a rollover from an eligible retirement plan within the 5-year period.   If, within the 5-year period starting with the first day of your tax year in which you rolled over an amount from an eligible retirement plan to a Roth IRA, you take a distribution from the Roth IRA, you may have to pay the additional 10% tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the rollover that you had to include in income. The additional tax is figured on Form 5329. For more information, see Form 5329 and its instructions. For information on qualified distributions from Roth IRAs, see Additional Tax on Early Distributions in chapter 2 of Publication 590.

Distributions from designated Roth accounts allocable to in-plan Roth rollovers within the 5-year period.   If, within the 5-year period starting with the first day of your tax year in which you rolled over an amount from a 401(k), 403(b), or 457(b) plan to a designated Roth account, you take a distribution from the designated Roth account, you may have to pay the additional 10% tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the in-plan rollover that you had to include in income. The additional tax is figured on Form 5329. For more information, see Form 5329 and its instructions. For information on qualified distributions from designated Roth accounts, see Designated Roth accounts under Taxation of Periodic Payments in Publication 575.

Exceptions to tax.    Certain early distributions are excepted from the early distribution tax. If the payer knows that an exception applies to your early distribution, distribution code “2,” “3,” or “4” should be shown in box 7 of your Form 1099-R and you do not have to report the distribution on Form 5329. If an exception applies but distribution code “1” (early distribution, no known exception) is shown in box 7, you must file Form 5329. Enter the taxable amount of the distribution shown in box 2a of your Form 1099-R on line 1 of Form 5329. On line 2, enter the amount that can be excluded and the exception number shown in the Form 5329 instructions.

  
If distribution code “1” is incorrectly shown on your Form 1099-R for a distribution received when you were age 59½ or older, include that distribution on Form 5329. Enter exception number “12” on line 2.

General exceptions.   The tax does not apply to distributions that are:
  • Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after your separation from service),

  • Made because you are totally and permanently disabled, or

  • Made on or after the death of the plan participant or contract holder.

Additional exceptions for qualified retirement plans.   The tax does not apply to distributions that are:
  • From a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55 (age 50 for qualified public safety employees),

  • From a qualified retirement plan (other than an IRA) to an alternate payee under a qualified domestic relations order,

  • From a qualified retirement plan to the extent you have deductible medical expenses that exceed 10% (or 7.5% if you or your spouse are age 65 or older) of your adjusted gross income, whether or not you itemize your deductions for the year,

  • From an employer plan under a written election that provides a specific schedule for distribution of your entire interest if, as of March 1, 1986, you had separated from service and had begun receiving payments under the election,

  • From an employee stock ownership plan for dividends on employer securities held by the plan,

  • From a qualified retirement plan due to an IRS levy of the plan,

  • From elective deferral accounts under 401(k) or 403(b) plans or similar arrangements that are qualified reservist distributions, or

  • Phased retirement annuity payments made to federal employees. See Pub. 721 for more information on the phased retirement program.

Qualified public safety employees.   If you are a qualified public safety employee, distributions made from a governmental defined benefit pension plan are not subject to the additional tax on early distributions. You are a qualified public safety employee if you provide police protection, firefighting services, or emergency medical services for a state or municipality, and you separated from service in or after the year you attained age 50.

Qualified reservist distributions.   A qualified reservist distribution is not subject to the additional tax on early distributions. A qualified reservist distribution is a distribution (a) from elective deferrals under a section 401(k) or 403(b) plan, or a similar arrangement, (b) to an individual ordered or called to active duty (because he or she is a member of a reserve component) for a period of more than 179 days or for an indefinite period, and (c) made during the period beginning on the date of the order or call and ending at the close of the active duty period. You must have been ordered or called to active duty after September 11, 2001. For more information, see Qualified reservist distributions under Special Additional Taxes in Publication 575.

Additional exceptions for nonqualified annuity contracts.   The tax does not apply to distributions from:
  • A deferred annuity contract to the extent allocable to investment in the contract before August 14, 1982,

  • A deferred annuity contract under a qualified personal injury settlement,

  • A deferred annuity contract purchased by your employer upon termination of a qualified employee plan or qualified employee annuity plan and held by your employer until your separation from service, or

  • An immediate annuity contract (a single premium contract providing substantially equal annuity payments that start within 1 year from the date of purchase and are paid at least annually).

Tax on Excess Accumulation

To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than your required beginning date (defined later). The payments each year cannot be less than the required minimum distribution.

Required distributions not made.   If the actual distributions to you in any year are less than the minimum required distribution for that year, you are subject to an additional tax. The tax equals 50% of the part of the required minimum distribution that was not distributed.

  For this purpose, a qualified retirement plan includes:
  • A qualified employee plan,

  • A qualified employee annuity plan,

  • An eligible section 457 deferred compensation plan, or

  • A tax-sheltered annuity plan (403(b) plan)(for benefits accruing after 1986).

Waiver.   The tax may be waived if you establish that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall. See the Instructions for Form 5329 for the procedure to follow if you believe you qualify for a waiver of this tax.

State insurer delinquency proceedings.   You might not receive the minimum distribution because assets are invested in a contract issued by an insurance company in state insurer delinquency proceedings. If your payments are reduced below the minimum due to these proceedings, you should contact your plan administrator. Under certain conditions, you will not have to pay the 50% excise tax.

Required beginning date.   Unless the rule for 5% owners applies, you generally must begin to receive distributions from your qualified retirement plan by April 1 of the year that follows the later of:
  • The calendar year in which you reach age 70½, or

  • The calendar year in which you retire from employment with the employer maintaining the plan.

However, your plan may require you to begin to receive distributions by April 1 of the year that follows the year in which you reach age 70½, even if you have not retired.

  If you reached age 70½ in 2013, you may be required to receive your first distribution by April 1, 2014. Your required distribution then must be made for 2014 by December 31, 2014.

5% owners.   If you are a 5% owner, you must begin to receive distributions by April 1 of the year that follows the calendar year in which you reach age 70½.

  You are a 5% owner if, for the plan year ending in the calendar year in which you reach age 70½, you own (or are considered to own under section 318 of the Internal Revenue Code) more than 5% of the outstanding stock (or more than 5% of the total voting power of all stock) of the employer, or more than 5% of the capital or profits interest in the employer.

Age 70½.   You reach age 70½ on the date that is 6 calendar months after the date of your 70th birthday.

  For example, if you are retired and your 70th birthday was on June 30, 2013, you were age 70½ on December 30, 2013. If your 70th birthday was on July 1, 2013, you reached age 70½ on January 1, 2014.

Required distributions.   By the required beginning date, as explained earlier, you must either:
  • Receive your entire interest in the plan (for a tax-sheltered annuity, your entire benefit accruing after 1986), or

  • Begin receiving periodic distributions in annual amounts calculated to distribute your entire interest (for a tax-sheltered annuity, your entire benefit accruing after 1986) over your life or life expectancy or over the joint lives or joint life expectancies of you and a designated beneficiary (or over a shorter period).

Additional information.   For more information on this rule, see Tax on Excess Accumulation in Publication 575.

Form 5329.   You must file Form 5329 if you owe tax because you did not receive a minimum required distribution from your qualified retirement plan.

Survivors and Beneficiaries

Generally, a survivor or beneficiary reports pension or annuity income in the same way the plan participant would have. However, some special rules apply. See Publication 575 for more information.

Survivors of employees.   If you are entitled to receive a survivor annuity on the death of an employee who died, you can exclude part of each annuity payment as a tax-free recovery of the employee's investment in the contract. You must figure the taxable and tax-free parts of your annuity payments using the method that applies as if you were the employee.

Survivors of retirees.   If you receive benefits as a survivor under a joint and survivor annuity, include those benefits in income in the same way the retiree would have included them in income. If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule and recovered all of the cost tax free, your survivor payments are fully taxable.

   If the retiree was reporting the annuity payments under the General Rule, you must apply the same exclusion percentage to your initial survivor annuity payment called for in the contract. The resulting tax-free amount will then remain fixed. Any increases in the survivor annuity are fully taxable.

   If the retiree was reporting the annuity payments under the Simplified Method, the part of each payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. This amount remains fixed even if the annuity payments are increased or decreased. See Simplified Method , earlier.

  In any case, if the annuity starting date is after 1986, the total exclusion over the years cannot be more than the cost.

Estate tax deduction.   If your annuity was a joint and survivor annuity that was included in the decedent's estate, an estate tax may have been paid on it. You can deduct the part of the total estate tax that was based on the annuity. The deceased annuitant must have died after the annuity starting date. (For details, see section 1.691(d)-1 of the regulations.) Deduct it in equal amounts over your remaining life expectancy.

  If the decedent died before the annuity starting date of a deferred annuity contract and you receive a death benefit under that contract, the amount you receive (either in a lump sum or as periodic payments) in excess of the decedent's cost is included in your gross income as income in respect of a decedent for which you may be able to claim an estate tax deduction.

  You can take the estate tax deduction as an itemized deduction on Schedule A, Form 1040. This deduction is not subject to the 2%-of-adjusted-gross-income limit on miscellaneous deductions. See Publication 559, Survivors, Executors, and Administrators, for more information on the estate tax deduction.


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