| Pub. 17, Your Federal Income Tax |
2005 Tax Year |
10.
Retirement Plans, Pensions, and Annuities
Katrina Emergency Tax Relief Act of 2005. This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may qualify for tax-favored withdrawals,
recontributions, and loans. See Publication 4492.
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.
Civil service retirement benefits.
If you are retired from the federal government (either regular 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.
Individual retirement arrangements (IRAs).
Information on the tax treatment of amounts you receive from an IRA is in chapter 17.
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
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 this
credit, 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.
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 separately. Your former employer or the plan administrator should be able
to tell you if you have more
than one pension or annuity contract.
Railroad retirement benefits.
Part of the railroad retirement benefits you receive is treated for tax purposes like social security benefits, and
part is treated like 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 in Publication 575.
Credit for the elderly or the disabled.
If you receive a pension or annuity, you may be able to take the credit for the elderly or the disabled. See chapter
33.
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 choose not to have tax withheld unless they are eligible rollover distributions. See Eligible rollover distributions
under Rollovers, later. You make this choice by filing Form W-4P.
For payments other than eligible rollover distributions, you
can tell the payer how to withhold by filing Form W-4P. If you receive an eligible rollover distribution, 20% will generally
be withheld. There is no
withholding on a direct rollover of an eligible rollover distribution. See Direct rollover option under Rollovers, later. If you
choose not to have tax withheld or you do not have enough tax withheld, you may have to pay estimated tax.
For more information, see Pensions and Annuities under Withholding in chapter 4.
Loans.
If you borrow money from your qualified pension or annuity plan, tax-sheltered annuity program, government plan, or
contract purchased under any of
these plans, you may have to treat the loan as a nonperiodic distribution unless certain exceptions apply. 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.
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.
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 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.
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.
For general information on these deferred compensation plans, see Section 457 Deferred Compensation Plans in Publication 575.
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.
Tax-free exchange.
You do not recognize gain or loss 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.
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 everything that you paid. It also
includes amounts your
employer paid that were taxable to you when paid. Cost does not include any amounts you deducted or excluded from income.
From this total cost, subtract any refunds of premiums, rebates, dividends, unrepaid loans, or other tax-free amounts 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.
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
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 annuity, you are not taxed on the part of the annuity you receive that represents
a return of your cost. The
rest of the amount you receive is taxable. Your annuity starting date determines which method you must or may use.
If you contributed to your pension or annuity plan, you figure the tax-free and the taxable parts of your annuity
payments under either the
Simplified Method or the General Rule. 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 only for nonqualified plans.
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.
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 receive pension
or annuity payments from a
qualified plan or annuity, unless you were at least 75 years old and entitled to annuity payments from a qualified plan that
are guaranteed for 5
years or more.
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.
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
described above. 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.
Exclusion limit.
Your annuity starting date determines the total amount that you can exclude from your taxable income over the years.
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.
How to use the Simplified Method.
Complete the Simplified Method Worksheet in Publication 575 to figure your taxable annuity
for 2005. If the annuity is payable only over your life, use your age at the annuity starting date to determine the total
number of expected monthly
payments for your annuity. For annuity starting dates beginning in 1998, if your annuity is payable over your life and the
lives of other individuals,
use the combined ages of you and the youngest survivor annuitant at the annuity starting date. However, if your annuity starting
date began before
January 1, 1998, the total number of monthly annuity payments expected to be received is based on the primary annuitant's
age at the annuity starting
date.
Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity in later years.
Example.
Bill Smith, age 65, began receiving retirement benefits in 2005, under a joint and survivor annuity. Bill's annuity starting
date is January 1,
2005. 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.
Had Bill's retirement annuity payments been from a nonqualified plan, he would have used the General Rule. He uses the Simplified
Method Worksheet
because his annuity payments are from a qualified plan.
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
|
2. |
31,000 |
|
|
| |
Note: If your annuity starting date wasbefore 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. 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
|
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 on line 9
instead. |
|
|
| 10. |
Add lines 6 and 8
|
10. |
1,200 |
| 11. |
Balance of cost to be recovered. Subtract line 10 from line 2
|
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
|
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.
Corrective distributions of excess plan contributions.
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. 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. 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 and, if it is made under a nonqualified
plan, whether it fully
discharges the contract or is allocable to an investment you made before August 14, 1982.
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.
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, it is generally
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.
For more information, see Figuring the Taxable Amount, under Taxation of Nonperiodic Payments, in Publication 575.
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 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.
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 rates shown in the instructions
for Part III to
figure the tax. Publication 575 illustrates how to complete Form 4972 to figure the separate tax.
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.
Time for making rollover.
You generally must complete the rollover by the 60th day following the day on which you receive the distribution from
your employer's plan. (This
60-day period is extended for the period during which the distribution is in a frozen deposit in a financial institution.)
For all rollovers to an
IRA, you must irrevocably elect rollover treatment by written notice to the trustee or issuer of the IRA.
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.
Eligible rollover distributions.
Generally, an eligible rollover distribution is any distribution of all or 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
or traditional IRA. The transfer must be made either through a direct rollover to a qualified plan that separately accounts
for the taxable and
nontaxable parts of the rollover or through a rollover to a traditional 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.
Direct rollover option.
You can choose to have any part or all of an eligible rollover distribution paid directly to another qualified plan
(if permitted) or to a
traditional IRA. If you decide on a rollover, it is generally to your advantage to choose this direct rollover option. Under
this option, the plan
administrator would not withhold tax from any part of the distribution that is directly paid to the other plan.
Withholding tax.
If you choose to have all or any part of the distribution paid to you, it is taxable in the year distributed unless
you roll it over to another
qualified plan or to a traditional IRA within 60 days. The plan administrator must withhold income tax of 20% from the amount
of the distribution paid
to you. (See Pensions and Annuities under Withholding 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.
The administrator must give you a written explanation of your distribution options within a reasonable period of time
before making an eligible
rollover distribution.
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 IRA.
A beneficiary other than the employee's surviving spouse cannot roll over a distribution.
Alternate payee under qualified domestic relations order.
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 qualified domestic
relations order (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 Publication 575 for more information on benefits received under a QDRO.
Retirement bonds.
If you redeem a retirement bond purchased under a qualified bond purchase plan, you can defer the tax on the amount
received that exceeds your
basis by rolling it over to an IRA or qualified employer plan as discussed in Publication 590.
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:
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 60 and write “No” under the heading “Other Taxes” to the left of line 60.
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).
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 by 5% instead of 10%. Attach an explanation
to your return.
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 “ 11” 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) if you separated from service in or after the year you reached age 55,
-
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 (medical expenses that exceed 7.5% 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, or
-
From a qualified retirement plan due to an IRS levy of the plan.
Additional exceptions for nonqualified annuity contracts.
The tax does not apply to distributions that are:
-
From a deferred annuity contract to the extent allocable to investment in the contract before August 14, 1982,
-
From a deferred annuity contract under a qualified personal injury settlement,
-
From 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
-
From an immediate annuity contract (a single premium contract providing substantially equal annuity payments that start within
one year from
the date of purchase and are paid at least annually).
Tax on Excess Accumulations
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 next).
The payments each year
cannot be less than the minimum required distribution.
Required beginning date.
Unless the rule for 5% owners applies, you 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 701/, even if you have not retired.
For this purpose, a qualified retirement plan includes a:
-
Qualified employee plan,
-
Qualified employee annuity plan,
-
Section 457 deferred compensation plan, or
-
Tax-sheltered annuity plan (for benefits accruing after 1986).
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, 2005, you were age 70½ on December 30, 2005.
If your 70th
birthday was on July 1, 2005, you reached age 70½ on January 1, 2006.
5% owners.
If you are a 5% owner of the company maintaining your qualified retirement plan, you must begin to receive distributions
by April 1 of the calendar
year that follows the year in which you reach age 70½, regardless of when you retire.
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.
Required distributions not made.
If the actual distributions to you in any year are less than the minimum required distribution, you are subject to
an additional excise tax. The
tax equals 50% of the part of the minimum required distribution that was not distributed. You can get this excise tax waived
if you establish that the
shortfall in distributions was due to reasonable error and that you are taking reasonable steps to remedy the shortfall.
State insurer delinquency proceedings.
You might not receive the minimum distribution because of state insurer delinquency proceedings for an insurance company.
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
excise tax.
Form 5329.
You must file a Form 5329 if you owe a tax because you did not receive a minimum required distribution from your qualified
retirement plan.
If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule,
include the total
received in income.
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 for
future payments. 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. See Simplified Method,
earlier.
If you are the survivor of an employee, or former employee, who died before becoming entitled to any annuity payments, you
must figure the taxable
and tax-free parts of your annuity payments using the method that applies as if you were the employee.
Estate tax.
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, as a miscellaneous itemized deduction, the part of the total estate tax that was based on the annuity. This deduction
is not subject to the
2%-of-adjusted gross-income limit. The deceased annuitant must have died after the annuity starting date. (For details, see
section 1.691(d)-1 of the
regulations.) This amount cannot be deducted in one year. It must be deducted 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.
See Publication 559, Survivors, Executors, and Administrators, for more information on the estate tax deduction.
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