There are two general rules when it comes to the taxation of pensions. The first rule is that any money you receive from a pension or retirement plan that you did not contribute to or you used tax free money to contribute to will be entirely taxable to you. An example of this type of plan would be where the retirement plan or pension is entirely funded by an employer and the employee does not contribute or deposit any of their own money or wages into the plan.
The second rule is that any money you receive from a pension or retirement plan that you contributed to by using already taxed money will only be partially taxable to you. An example of this type of plan is when an employee is paid from their employer and then the employee takes those wages and invests them into a retirement plan. The amount of money invested into the plan by the employee is not taxable because it was already taxed. However, any gains that occur because of that money are going to be fully taxable because the gains were not taxed before.
There is also a 10% penalty on any money that is taken out of a pension or retirement plan before the person reaches age 59.5. This means that any money received from a pension or retirement plan before age 59.5 will be taxed at that person’s normal income tax rate plus an additional 10% for withdrawing the funds early.
However, there are a few exceptions to this rule, such as permanent disabilities, death of a plan participant, or equal periodic payments. If you or someone you know is having tax issues, you can reach us at Hoorfarlaw.com or 816-524-4949.