CARL WATTS & ASSOCIATES

May 01, 2017

Troubles viewing this message? View in browser online here
Retirement Benefits Taxation
(1) Pensions and Annuities
Everybody knows what retirement benefits are and, hopefully, we will all be able to benefit from our retirement for a long time!

More often than not, the crucial factor to consider for retirement has less to do with age and more to do with financial independence achieved with enough savings, investment income, and/or pension income to cover for all living expenses.

Retirement benefits may be roughly separated into two categories: (1) pensions and annuities, and (2) social security and equivalent railroad retirement benefits.

When it comes to taxation, the best choice is to rely on the IRS for the right definition of relevant terms such as “pension” and “annuity”, so here we go.

A pension is generally a series of definitely determinable payments made to you after you retire from work. Pension payments are made regularly and are based on such factors as years of service and prior compensation.


An annuity is a series of payments under a contract made at regular intervals over a period of more than one full year. They can be either fixed (under which you receive a definite amount) or variable (not fixed). You can buy the contract alone or with the help of your employer.


There are several types of pensions and annuities.

Fixed-period annuities are annuities which enable you to receive definite amounts at regular intervals for a specified length of time.

Annuities for a single life indicate that you receive definite amounts at regular intervals for life and that the payments end at death.

With joint and survivor annuities, the first annuitant receives a definite amount at regular intervals for life. After he or she dies, a second annuitant receives a definite amount at regular intervals for life. The amount paid to the second annuitant may or may not differ from the amount paid to the first annuitant.

Variable annuities refer to payments that may vary in amount for a specified length of time or for life. The amounts you receive may depend upon such variables as profits earned by the pension or annuity funds, cost-of-living indexes, or earnings from a mutual fund.

Disability pensions are payments you receive because you retired on disability and haven't reached minimum retirement age. These can be military and government disability pensions, or employer disability pensions.

A qualified employee plan is an employer's stock bonus, pension, or profit- sharing plan that is for the exclusive benefit of employees or their beneficiaries and that meets Internal Revenue Code requirements. It qualifies for special tax benefits, such as tax deferral for employer contributions and capital gain treatment or the 10-year tax option for lump-sum distributions (if participants qualify). To determine whether your plan is a qualified plan, check with your employer or the plan administrator.


A qualified employee annuity is a retirement annuity purchased by an employer for an employee under a plan that meets Internal Revenue Code requirements.

The majority of retirement savings programs offered by employers are qualified plans and contributions are tax-deductible. There are several types of qualified plans and, of course, some are more common than others.

The most common type is the defined-contribution plan, which means that the employer and/or employee contribute a set amount to the employee's individual account and the total account balance depends on the amount of those contributions and the rate at which the account accrues interest. Depending on the plan, the employer may not be required to contribute at all and the accrual of funds depends on how much the employee chooses to contribute.

For the most part, these plans are tax- deferred, meaning contributions are made with pre-tax dollars, and the employee pays income taxes on funds in the year they are withdrawn.

If you are self-employed, you have many of the same options of retirement plans on a tax-deferred basis as employees participating in company plans.

If you receive retirement benefits in the form of pension or annuity payments from a qualified employer retirement plan, all or some portion of the amounts you receive may be taxable.

The pension or annuity payments that you receive are fully taxable if you have no investment in the contract due to any of the following situations:

  • You did not contribute anything or are not considered to have contributed anything for your pension or annuity,
  • Your employer did not withhold contributions from your salary, or
  • You received all of your contributions (your investment in the contract) tax free in prior years.



If you contributed after-tax dollars to your pension or annuity, your pension payments are partially taxable. You will not pay tax on the part of the payment that represents a return of the after-tax amount you paid. This amount is your investment in the contract, and includes the amounts your employer contributed that were taxable to you when contributed.

You figure the tax on partly taxable pensions by using either the General Rule or the Simplified Method.

If the starting date of your pension or annuity payments is after November 18, 1996, you generally must use the Simplified Method to determine how much of your annuity payment is taxable and how much is tax-free.

If you began receiving annuity payments from a qualified retirement plan after July 1, 1986 and before November 19, 1996, you generally could have chosen to use either the Simplified Method or the General Rule to figure the tax-free part of the payments.

If you receive annuity payments from a non-qualified retirement plan, you must use the General Rule. Under the General Rule, you figure the taxable and tax- free parts of your annuity payments using life expectancy tables prescribed by the IRS. For a fee, the IRS will figure the tax-free part of your annuity payments for you.


If you receive pension or annuity payments before age 591⁄2, you may be subject to an additional 10% tax on early distributions, unless the distribution qualifies for an exception. The additional tax does not apply to any part of a distribution that is tax-free or to any of the following types of distributions:

  • Distributions made as a part of a series of substantially equal periodic payments that begins after your separation from service,
  • Distributions made because you are totally and permanently disabled,
  • Distributions made on or after the death of the plan participant or contract holder, and
  • Distributions made after your separation from service and in or after the year you reached age 55.

The taxable part of your pension or annuity payments is generally subject to federal income tax withholding.

You may be able to choose not to have income tax withheld from your pension or annuity payments (unless they are eligible rollover distributions) or may want to specify how much tax is withheld. If so, you should provide the payer Form W-4P, Withholding Certificate for Pension or Annuity Payments, or a similar form provided by the payer.

If you are a U.S. citizen or resident alien and you do not provide the payer a home address in the United States or its possessions, you cannot choose to have no tax withheld.

Payers generally figure the withholding from periodic payments of a pension or annuity the same way as for salaries and wages. If you do not submit the withholding certificate, the payer must withhold tax as if you were married and claiming three withholding allowances. Even if you submit a Form W-4P and elect a lower amount, if you do not provide the payer with your correct Social Security number, tax will be withheld as if you were single and claiming no withholding allowances.

If you pay your taxes through withholding and the withheld tax is not enough, you may also need to make estimated tax payments to ensure you do not underpay taxes during the tax year.

Special rules apply to certain non-periodic payments from qualified retirement plans.

If you receive an eligible rollover distribution, the payer must withhold 20% of it, even if you intend to roll it over later. You can avoid this withholding by choosing the direct rollover option. A distribution sent to you in the form of a check payable to the receiving plan or IRA is not subject to withholding.

If you live in a foreign country and receive a pension/annuity paid by a U.S. payor, you may claim an exemption from withholding of U.S. Federal Income Tax (FIT) under a tax treaty by completing Form W-8BEN and delivering it to the U.S. payor. You must report your U.S. Taxpayer Identification Number (TIN) on Form W-8BEN for it to be valid for treaty purposes.

If you live in the USA and receive a pension/annuity paid by a payor from a foreign country, you must claim your desired treaty withholding exemption on the form, and in the manner specified by the foreign government.

If the foreign government, and/or the foreign withholding agent, refuses to honor the treaty claim, make the treaty claim on your income tax return, or other prescribed form, filed with the foreign country.

Additionally, you may be able to claim a Foreign Tax Credit on your U.S. federal individual income tax return for any foreign income tax withheld from your foreign pension or annuity.

Life is supposed to be simpler after retirement but, unless you are a wise retiree who gets help from a tax or financial advisor, the multitude of IRS rules and regulations and the complex calculations they involve may become a burden harder to bear than old age. And do remember that money may not be better in retirement, but the hours are!
TOP
Repeated issues with image download?
This may be helpful.
Click here !
www.carlwatts.com
office@carlwatts.com
Washington DC
tel/fax 202 350-9002