IRS Publication 575 offers valuable insights on how to handle the taxation of pension and annuity income. It provides taxpayers with the necessary steps for reporting these income sources, ensuring accurate tax filings and compliance.
Key Facts About Publication 575
- Publication 575 guides reporting of pension and annuity income, including tax treatment for qualified and non-qualified plans.
- Annuity earnings are taxed, with qualified annuities taxed on both principal and earnings.
- Report pension and annuity income using Form 1099-R with your tax return.
- Publication 575 excludes non-qualified annuities and IRAs; refer to other IRS guides for those.
What Is Publication 575?
Publication 575 is a detailed document from the Internal Revenue Service (IRS) that provides guidance on how to report distributions received from pensions and annuities on your tax return. While both pensions and annuities can provide income in retirement, the two types of investment vehicles are fundamentally different, as outlined below.
- Pensions are retirement plans sponsored by employers. They provide a lifetime payout to retired workers. The payout amount is typically based on years of service and earnings.
- Annuities are financial contracts sold by life insurance companies. They provide a stream of future income in exchange for an upfront payment. Annuities can be structured to provide income for life, and many contracts offer customizable features to meet your financial objectives.
I recently worked with a married, retired couple with pre-tax IRAs who sought to convert some savings to a Roth IRA for tax-free withdrawals and to avoid required minimum distributions (RMDs), enhancing flexibility and leaving a tax-free inheritance to their children. Without early withdrawal penalties, they focused on the tax impact of the conversion while considering how increased modified adjusted gross income (MAGI) might affect their Medicare IRMAA premiums in two years. Balancing long-term goals with short-term tax consequences, we devised a multi-year Roth conversion plan to minimize current taxes and maximize future retirement savings.
Peggy James, CPAIndependent Accountant and Financial CoachPeggy James is a certified public accountant with a Master of Accounting. She has spent the past several years of her career focused on working in higher education finance roles. Peggy also has accounting and finance experience working in the corporate and nonprofit sectors.
Where Can You Find Publication 575?
Publication 575 is updated each year by the IRS. The document explains the tax treatment of distributions from pensions and annuities and describes how to report the income on your federal income tax return. The easiest way to find the document is by visiting the Publication 575 page on the IRS website.
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What Does Publication 575 Cover?
According to the IRS, Publication 575 specifically covers the following topics:
- How to figure the tax-free part of periodic payments under a pension or annuity plan, including using a simple worksheet for payments under a qualified plan
- How to figure the tax-free part of nonperiodic payments from qualified and non-qualified plans, and how to use the optional methods to figure the tax on lump-sum distributions from pension, stock bonus and profit-sharing plans
- How to roll over certain distributions from a retirement plan into another retirement plan or individual retirement account (IRA)
- How to report disability payments, and how beneficiaries and survivors of employees and retirees must report benefits paid to them
- How to report railroad retirement benefits
- When additional taxes on certain distributions may apply (including the tax on early distributions and the tax on excess accumulation)
What Is Not Covered in Publication 575?
Publication 575 does not comprehensively cover non-qualified annuity taxation and the tax treatment of funds received from non-qualified pensions. For information relating to these types of non-qualified plans, see the page about Publication 939 on the IRS website.
Additionally, Publication 575 does not cover the treatment of individual retirement accounts (IRAs), civil service retirement benefits and tax-sheltered annuity plans, which are commonly referred to as 403(b) plans. For IRS guidance on these topics, visit the following links:
- Publication 590-B, Distributions from IRAs
- Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits
- Publication 571, Tax-sheltered Annuity Plans For Employees of Public Schools and Certain Tax-exempt Organizations
Worried About Your Retirement Savings?
How Are Your Annuity Distributions Taxed?
Annuities are designed to help you build wealth and facilitate future income payouts through tax deferral. This means that the interest earned in an annuity can grow free of taxation, which is a powerful savings advantage. The rate at which your investment accumulates is enhanced even more due to the power of compounding.
Generally, the interest earned with an annuity is not taxed until withdrawal. However, tax treatment varies, depending on whether you own a qualified or non-qualified annuity.
A qualified annuity, which allows for tax deductions, is purchased with pre-tax dollars. A non-qualified annuity is purchased with money that has already been taxed.
When you receive a distribution from a qualified annuity, the entire amount, including principal and earnings, is subject to ordinary income tax. With a non-qualified annuity, since you already paid tax on the money used to make the purchase, only the earnings are taxable. However, if the annuity was purchased within a retirement account with a Roth structure, the earnings are not taxable.
How Do You Report Your Annuity and Pension Income to the IRS?
Income received from an annuity or pension is reported to the IRS with Form 1099-R, which you should include with your annual tax filing. Generally, anyone who receives a distribution of $10 or more from an annuity or pension will receive a 1099-R on or before January 31 of each year. If you receive money from multiple payers, you will receive multiple forms.
All 1099-R distributions are reported to the IRS, but not all distributions are subject to taxation. Please consult with a tax professional to ensure your tax filings are accurately prepared.
