There have been many changes and provisions affecting tax holdings and contributions for pension plans since the signing of the Pension Protection Act in 2006. Tax is calculated on a pension by what is called the Simplified Method formula. This formula calculates a taxpayer's cost basis for each monthly pension payment when calculating pension tax. The Simplified method takes into account the number of payments based on the taxpayer's age and the pension start date. (see reference 1)
Get a Simplified Method Worksheet with instructions provided to calculate the taxable portion of your pension. This worksheet calculates the pension tax amount owed for the current taxable year and can be found in 1040 or 1040A tax return forms. You can request a 1040 or 1040A tax return from the IRS, pick them up at the post office, or find a printable version online to help calculate the amount of pension taxed owed. While both forms allow income from retirement plans as well as wages, the main difference between the 1040 long form and the 1040 A form is in the 1040 you itemise your deductions and in the 1040 A you do not.
Calculate the total dollar amount paid into your pension plan for the current tax year. To determine your pension plan cost, multiply your monthly pension payment amount by the number of payments you made in the previous year that is subject to taxation.
Calculate the total number of payments based on your age at the time you began paying into the pension fund. Find your specific age ratio divider number in the age ratio table found in the Simplified Method worksheet. This is the number that represents the number of payments to use in your formula. Refer to the Simplified Method Worksheet section of your 1040 or 1040A tax return forms to locate the age table to find your specific number of payment months. This number is specific to your age at the date at which you started your plan.
Divide your plan cost by the number of payments found in the age table and multiple that number by the number payment months made in the taxable year. Subtract all tax amounts recovered during the current tax year from this number if applicable. Then subtract your final amount from the total dollar amount paid into the pension plan to your find your taxable amount. The entire formula is as follows: taxpayer cost basis divided by the number of monthly payments equals the monthly tax free portion.
Don't forget to include any 1099 amounts in the payment section when filling out a 1040 or 1040A form.
Tips and warnings
- Don't forget to include any 1099 amounts in the payment section when filling out a 1040 or 1040A form.