IRS Publication 575: Pension & Annuity Income
Retirement income is one of the most complex areas of tax law — and mistakes can trigger IRS notices, penalties, and unexpected tax bills. Publication 575 explains how pensions, annuities, and retirement plan distributions are taxed, how the Simplified Method works, what happens with lump-sum payouts, and how to avoid the 10% early distribution penalty.
How Retirement Distributions Are Taxed
Taxable Pension Distributions
Most pension and annuity payments are fully taxable as ordinary income if your employer funded the plan. If you made after-tax contributions, the Simplified Method determines the tax-free portion. Traditional IRA, 401(k), 403(b), and 457 plan distributions are generally 100% taxable unless you have after-tax basis in the account.
The Simplified Method
The IRS-prescribed method for calculating the tax-free portion of annuity payments. Divide your after-tax contributions (cost basis) by the expected number of payments based on your age using IRS actuarial tables. The result is your monthly tax-free amount. Once you recover your full cost basis, all remaining payments become fully taxable.
Lump-Sum Distributions
Taking your entire retirement balance in one year can push you into much higher tax brackets. Special rules apply for pre-1974 plan participants: 10-year forward averaging (using 1986 tax rates) and capital gain treatment for pre-1974 contributions. These options are only available if you were born before January 2, 1936, and only once in your lifetime.
Rollover Rules
You have 60 days from receiving a distribution to roll it over to another qualified plan or IRA to avoid current taxation. If the check is made payable to you, the plan must withhold 20% for federal taxes — you'll need to make up that amount from other funds to complete a full rollover. Direct trustee-to-trustee transfers avoid mandatory withholding entirely.
Required Minimum Distributions
RMDs must begin by April 1 of the year after you reach age 73 (age 75 starting in 2033). Failure to take the correct RMD triggers a 50% excise tax on the shortfall — reduced to 25% under SECURE 2.0 if corrected within two years. Roth IRAs have no lifetime RMDs. Employer plans may permit RMD delays if you are still working and do not own more than 5% of the business.
Common Issues & Penalty Exceptions
10% Early Distribution Exceptions
The 10% additional tax on pre-59 1/2 withdrawals does not apply if you: separate from service at age 55+ (age 50 for public safety employees); take substantially equal periodic payments under IRC 72(t); are totally and permanently disabled; use funds for unreimbursed medical expenses exceeding 7.5% of AGI; or receive distributions as a beneficiary after the account holder's death. Each exception has strict qualification requirements.
Missed RMDs & Penalties
Missing an RMD triggers a 25% excise tax on the shortfall (reduced from 50% under SECURE 2.0). File Form 5329 to report the penalty and request a waiver by showing reasonable cause. The IRS often abates the penalty if you correct the error promptly and attach a letter explaining the oversight. Correct missed RMDs immediately — the penalty accrues each year the shortfall remains uncorrected.
Net Unrealized Appreciation (NUA)
If you hold employer stock in your 401(k), the NUA rules let you pay ordinary income tax only on the stock's cost basis at distribution. The appreciation above basis is taxed at long-term capital gains rates when you sell — even if you sell immediately. This can create significant tax savings compared to rolling the stock into an IRA where all withdrawals are taxed as ordinary income.
Qualified Charitable Distributions
If you are age 70 1/2 or older, you can direct up to $105,000 per year (2026, inflation-adjusted) from your IRA directly to a qualified charity. The QCD counts toward your RMD requirement but is excluded from your taxable income — effectively a 100% deduction even if you take the standard deduction. The transfer must go directly from the IRA custodian to the charity; you cannot receive the funds first.