If an employee retires before reaching age fifty-nine and a half, his or her pension payments are taxed at a 10 percent annual rate in addition to any regular income taxes. This excise tax is levied because pension funds are designed to promote security after retirement. The excise tax does not apply to a pension given to a surviving spouse when the employee dies before the pension is fully paid, even if the employee dies before reaching age fifty-nine and a half. Employees who become disabled before age fifty-nine and a half do not have to pay the excise tax, nor do persons who specifically choose to receive the pension payments as an annuity, or periodically. Congress refined the tax consequences of pensions in January 1996.
Pensions are an attractive component of employee compensation packages.
The money that the employer withholds during the working life of the employee is not taxed, and the money in a pension fund can be increased through investments. When the pensioned employee retires, she or he can ask for the entire pension in one lump sum or can take the pension as an annuity, which is a series of payments that lasts for a specified period of time. If the retiree lives long enough, she or he will receive more money than the employer originally withheld. If the pensioner dies before the pension is fully paid, her or his surviving spouse or another designated survivor may receive the remainder of the pension. A retiree who has worked at several companies may receive several pensions.