Pensions can take many different forms, including 401(k)s, employer retirement programs and various types of savings plans. How pensions and IRAs are affected by taxes depends on a number of factors, including the type of account, the age of the account owner and his level of income. How an account is handled can also affect the taxes.
A pension plan can be either wholly funded by an employer, by the employee alone or by a combination of employer and employee funds. The money is typically placed in a qualified savings or pension plan that meets IRS requirements. Employees are typically vested in pension plans based on their amount of time with the employer, though any funds the employee has put into the fund are vested immediately. Only vested money can be removed from a pension.
There are different kinds of IRAs. Most contain pre-tax dollars, and no taxes are due on them until the money is withdrawn. Although IRAs are typically owner-funded, two types are designed to allow employers to contribute as well. These are the simplified employee pension IRAs (SEP IRAs), and savings incentive match plans (SIMPLE) IRAs. Funds rolled over into an IRA follow the rules that apply to that type of IRA.
A roll over occurs when money from one type of a retirement account is moved into another qualified account. When money is rolled over into an IRA, it is normally not taxed until the account owner has the money distributed to him when he reaches retirement age. The exception to this is a Roth IRA. Money rolled over into a Roth IRA is taxed as income at the time of the roll over, since money in a Roth account is after-tax money.
Taxes are due on most pension plans at the time the money is withdrawn from the account. It is taxed as regular income when the account holder receives it. How much tax she pays depends on what other income and deductions she has each year. The exception to this is a Roth IRA, which contains funds that have already had taxes paid on them. Money taken from a Roth account is not subject to income taxes. On any type of pension account, however, if the money is withdrawn before the account holder reaches the retirement age of 59 1/2, not only are income taxes due on the money received, except the Roth, but there is also a 10 percent tax penalty in most cases.
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