How is a pension taxed?

As a pension fund is growing during an employee’s working years, it is usually funded with pre-tax dollars and the money going into the pension is not taxed at that time.  However, when a person retires and begins receiving his pension, the monthly payments will be taxed as ordinary income in most cases.  If the employer fully funded the pension with pre-tax dollars, all of the pension payments will be taxed to the retiree; however, if the employee also contributed to his pension through payroll or otherwise with after-tax dollars, then only the portion contributed by the employer will be taxed.  Thus, the question of how much of your pension payments will be taxed depends on what percentage of your pension was funded by pre-tax dollars and what percentage was funded by after-tax dollars.  This tax scheme is true for company pensions, 401-K’s and IRA’s. Remember that if one takes money out of a pension, IRA or 401-K prior to reaching the age of 59 ½, there will be a 10% early withdrawal penalty imposed on the withdrawal in addition to the taxes.