Chapter 9
Pensions & Annuities

Generally, pension and annuity payments are subject to Federal income tax withholding. The withholding rules apply to the taxable part of payments from an employer pension, annuity, profit-sharing, stock bonus, or other deferred compensation plan. The rules also apply to payments from an individual retirement arrangement (IRA), an annuity, endowment, or life insurance contract issued by a life insurance company. There is no withholding on any part of a distribution that is not expected to be includible in the recipient's gross income.

Generally, recipients of payments described above can choose not to have withholding apply to their pensions or annuities (however, see Mandatory Withholding below). The election remains in effect until the recipient revokes it. The payer must notify the recipient that this election is available.

Withholding

Periodic Payments

Generally, periodic payments are pension or annuity payments made for more than 1 year that are not eligible rollover distributions (see discussion below). Periodic payments include substantially equal payments made at least once a year over the life of the employee and/or beneficiaries or for 10 years or more. For withholding purposes, these payments are treated as if they are wages. You can figure withholding by using the recipient's Form W-4P, Withholding Certificate for Pension or Annuity Payments, and the income tax withholding tables and methods in Circular E or the alternative tables and methods in this publication.

Recipients of periodic payments can give you a Form W-4P to specify the number of withholding allowances and any additional amount they want withheld. They may also claim exemption from withholding on Form W-4P or revoke a previously claimed exemption. If they do not submit a Form W-4P, you must figure withholding by treating a recipient as married with three withholding allowances. See Form W-4P for more information.

Nonperiodic Payments

Withhold 10% of the taxable part of a nonperiodic payment that is not an eligible rollover distribution. The recipient may request additional withholding on Form W-4P or claim exemption from withholding.

Mandatory Withholding

Payments delivered outside the United States. The election to be exempt from income tax withholding does not apply to any periodic or nonperiodic payment delivered outside the United States or its possessions to a U.S. citizen or resident alien. See Form W-4P for more information.

Nonresident aliens can elect exemption from withholding only if they certify to the payer that they are not (1) a U.S. citizen or resident alien or (2) an individual to whom Internal Revenue Code section 877 applies (concerning expatriation to avoid tax). The certification must be made in a statement to the payer under penalties of perjury. However, nonresident aliens who choose such exemption will be subject to withholding under Code section 1441. See Pub. 515, Withholding of Tax on Nonresident Aliens and Foreign Corporations, and the Instructions for Form 1042-S.

Eligible rollover distributions. Withhold 20% of an eligible rollover distribution unless the recipient elected to have the distribution paid in a direct rollover to an eligible retirement plan, including an IRA. An eligible rollover distribution is the taxable part of any distribution from a qualified plan or tax-sheltered annuity (but not an IRA) except:

1. One of a series of substantially equal periodic payments (at least annually) made for the life or life expectancy of the employee and the employee's beneficiary or for a specified period of 10 years or more.
2. Any part of a distribution that is a minimum distribution required by Code section 401(a)(9).
3. A hardship distribution. A distribution will qualify for hardship if it is (a) made on account of immediate and heavy need and (b) necessary to satisfy the need. This includes medical and educational expenses and costs for purchasing a new residence, or to prevent eviction or foreclosure on a current residence.
4. Other exceptions apply. See the Form 1099-R instructions in the 2001 General Instructions for Forms 1099, 1098, 5498, and W-2G.

You are not required to withhold 20% of an eligible rollover distribution that, when added to other rollover distributions made to one person during the year, is less than $200.

A recipient of an eligible rollover distribution cannot claim exemption from the 20% withholding. However, a recipient may elect to have more than 20% withheld using Form W-4P. Do not provide the recipient a Form W-4P for eligible rollover distributions unless he or she wishes to request additional withholding in excess of the mandatory 20%.

Notice to recipient (section 402(f) notice). Generally, you must provide a written explanation to the recipient at least 30 but no more than 90 days before making an eligible rollover distribution. You must explain the rollover rules, special tax treatment for lump-sum distributions, direct rollover option, and the mandatory 20% withholding rule. Notice 92-48, 1992-2 C.B. 377, contains a model notice you can use to satisfy this requirement.

Similar rules apply to distributions from tax-sheltered annuities. The IRS has issued regulations on these requirements under sections 401(a)(31), 402, 403(b), and 3405.

Depositing and Reporting Withholding

Report income tax withholding from pensions and annuities on Form 945, Annual Return of Withheld Federal Income Tax. Do not report these liabilities on Form 941. You must furnish the recipients and the IRS with Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

Deposit withholding from pensions and annuities combined with any other nonpayroll withholding reported on Form 945 (e.g., backup withholding). Do not combine the Form 945 deposits with deposits for payroll taxes. Circular E and the separate Instructions for Form 945 include information on the deposit rules.

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