What Is the Federal Income Tax Rate on a Retirement Pension?

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The federal tax rate on pensions is your ordinary income tax rate; however, you'll only be taxed to the extent that you did not contribute any post-tax dollars to the pension fund. The same is true for taxes on IRA and 401(k) distributions made after retirement. Social Security benefits are only taxable if you have other income that exceeds certain amounts.

Tip

Pension payments are taxed as ordinary income unless you contributed post-tax money to the pension while you were working. Social Security benefits are only taxable if you make a certain amount of money from other sources.

What Is a Pension?

Pensions, also known as defined benefit plans, are retirement accounts set up for employees by employers that promise a specific payout upon retirement. Historically, employees did not contribute to pensions; however, there are now plans available that allow employees to contribute.

Private pension plans typically pay out based upon years of service, and this includes union plans. Public pension plans, which are pension plans for government employees, such as postal workers and law enforcement officers, are also based upon years of service but may pay out more.

In general, pensions promise that, if you work for a minimum number of years, you will receive a certain amount of money every month after you retire.

What Is Social Security?

Social Security is a system created by the federal government to alleviate the strain of the Great Depression. The Social Security Act was signed into law in 1935 as a way of providing the elderly with income when they were no longer able to work.

Social Security is funded by contributions from workers. When you earn wages, a percentage of those wages is paid to the Social Security fund. When you retire, you then receive a monthly distribution based on how much you contributed in your lifetime.

Social Security also provides benefits for people who are disabled and cannot work or are limited in how much they can work.

Federal Income Tax on Pensions and Social Security

Pensions are not a form of government assistance. When it comes to taxation, pensions are taxed in the same way as other retirement funds such as IRAs and 401(k) accounts. Pension income is taxed as ordinary income.

Social Security, on the other hand, is taxed at a graduated rate depending upon how much income you have from all sources.

Taxation of Pensions Fully Funded by an Employer

Regular pensions that are entirely funded by your employer are fully taxable, and you pay the ordinary income tax rates. If you didn't pay any money into the pension during your lifetime, your full pension benefits are taxable income. This means that if you didn't specifically make contributions or your employer didn't take any money out of your paycheck for your pension, everything you receive at retirement is taxable. If your monthly pension check is $1,000 per month, you'll pay ordinary income taxes on $1,000 per month.

Taxation of Pensions Partially Funded by the Employee

Some pension funds allow employees to make contributions to the fund. Contributions to retirement funds can either be made pretax or after tax.

Pretax contributions are taken out of gross pay, thus reducing the taxable income for the employee. When these funds are paid back at retirement, they're taxed at the regular rate.

After-tax contributions are made from net pay, after taxes have already been taken out. If you contribute to your pension from pretax funds, you'll be taxed on your distributions; if you contribute from post-tax funds, you won't be taxed because you paid the taxes before you contributed.

Penalty Tax on Early Pension Distributions

The official retirement age according to the IRS for distribution of retirement funds is 59 1/2. If you retire early before reaching 59 1/2, you might have to pay a 10 percent penalty on your pension distributions in addition to the regular income tax.

The 10 percent early retirement penalty doesn't apply if:

  • You retired early due to total and permanent disability.
  • You're collecting the pension because you were the beneficiary of a plan participant who passed away.
  • You retired during or after the year you reached the age of 55.
  • You elected to receive your pension payments in a Substantially Equal Periodic Payments plan. A SEPP plan allows you to elect to take your periodic payments in equal amounts every period based upon specific IRS calculations.
  • You left your job after your 55th birthday.

Taxation of Social Security Income

Social Security income you receive at retirement is only partially taxed, if at all, depending on your income from other sources.

If you're single and your total income is $25,000 or less, or if you're married filing jointly and your total income is $32,000 or less, your Social Security income is not subject to tax. This is true whether your benefits are for retirement or disability, as well as survivor benefits.

If you're single and your total income is between $25,000 and $34,000, up to 50 percent of your Social Security benefits can be taxed. If you're married filing jointly and your income is between $32,000 and $44,000, up to 50 percent of your benefits can be taxed.

Up to 85 percent of your Social Security benefits can be taxed if you're single and your income exceeds $34,000 or if you're married filing jointly and your income exceeds $44,000.

If your Social Security is taxed, it's taxed at the ordinary income tax rates.

The 2020 Ordinary Income Tax Brackets

The United States tax system provides for graduated taxation based on levels of ordinary income. Higher levels of income are taxed at higher rates. If your pension or Social Security income is taxed, it will be taxed at the ordinary income tax rates, just as if it were income from a job.

For the 2020 tax year, the tax rates for a single person are:

  • 10 percent of the first $9,875 of income.
  • 12 percent of all income between $9,875 and $40,125.
  • 22 percent of all income between $40,125 and $85,525.
  • 24 percent of all income between $85,525 and $163,300.
  • 32 percent of all income between $163,300 and $207,350.
  • 35 percent of all income between $207,350 and $518,400.
  • 37 percent of all income above $518,400.

If you're single and your sole source of income in 2020 is your pension, and you receive $2,500 per month from your pension fund, your annual income is $30,000. You'll pay 10 percent tax on the first $9,875 ($987.50) and 12 percent tax on the remaining $20,125 ($2,415) for a total tax of $3,402.50.

For a married couple, the tax rates are:

  • 10 percent of the first $19,750 of income.
  • 12 percent of all income between $19,750 and $80,250.
  • 22 percent of all income between $80,250 and $171,050.
  • 24 percent of all income between $171,050 and $326,600.
  • 32 percent of all income between $326,600 and $414,700.
  • 35 percent of all income between $414,700 and $622,050.
  • 37 percent of all income above $622,050.

For individuals filing as heads of household, the tax rates are:

  • 10 percent of the first $14,100 of income.
  • 12 percent of all income between $14,100 and $53,700.
  • 22 percent of all income between $53,700 and $85,500.
  • 24 percent of all income between $85,500 and $163,300.
  • 32 percent of all income between $163,300 and $207,350.
  • 35 percent of all income between $207,350 and $518,400.
  • 37 percent of all income above $518,400.
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