Are Defined Benefit Plans Taxable? Penalties, Medicare, and RMDs

Yes, defined benefit plans are taxable. Money you receive from a traditional pension is ordinary income in the year it’s paid, reported to you on Form 1099-R and taxed at your regular federal rate.¹² The only part that escapes tax is any after-tax money you personally contributed during your working years, which comes back to you gradually as a tax-free portion of each payment. How much you owe, and when, depends on the form your benefit takes: monthly checks, a lump sum, or a rollover into an IRA.

Monthly Pension Payments

If you take your pension as a stream of monthly payments, each check is taxed like a paycheck at your ordinary income rate. For retirees who never put after-tax dollars into the plan, every dollar of every payment is taxable.

If you did make after-tax contributions, the IRS calls that your “investment in the contract,” and you recover it tax-free over the life of your payments. For a qualified employer plan, you use the Simplified Method: divide your total after-tax contributions by a number of expected monthly payments from an IRS table keyed to your age at the annuity starting date.³ That gives you a fixed dollar amount to exclude from income each month. Once your full basis has been recovered, the exclusion ends and every later payment is fully taxable.

Lump-Sum Distributions

Taking the whole pension as a single lump sum collapses what might have been decades of income into one tax year. Without planning, that alone can push you into the 32% or 37% federal bracket. You have three basic choices.

Direct Rollover

In a direct rollover, your plan sends the money straight to a traditional IRA or another qualified plan. The funds never touch your bank account, no income tax is due at the time of transfer, and the money keeps its tax-deferred status.⁴ You pay tax later, as you draw from the IRA, spreading the hit over many years.

Indirect Rollover and the 20% Withholding Trap

If the plan writes the check to you instead, federal law requires 20% to be withheld for income taxes, even if you intend to roll the whole amount over.⁵ You then have 60 days to deposit the full original distribution amount into an eligible retirement account.⁴

Here is where people get caught. If the plan distributes $200,000 and withholds $40,000, you receive $160,000. To complete a tax-free rollover you must deposit $200,000 within 60 days, which means covering the $40,000 gap out of your own pocket. Deposit only the $160,000 you actually got, and the IRS treats the missing $40,000 as a taxable distribution. You’ll get credit for the $40,000 withholding at tax time, but it is gone from your retirement savings for good.

Keeping the Cash

If you don’t roll any of it over, the entire taxable portion becomes ordinary income that year. The 20% withheld is a down payment, not the final bill. If you’re under 59½, an additional penalty applies on top of the income tax.

The 10% Penalty Before Age 59½

Pulling money out of a qualified defined benefit plan before 59½ triggers a 10% additional tax on top of the regular income tax.⁶ On a $100,000 early distribution, that’s $10,000 before you count a dollar of income tax. Several exceptions remove the penalty, though income tax still applies.

The most useful exception for pension holders is separation from service at or after age 55. If you leave your employer in or after the calendar year you turn 55, distributions from that employer’s plan are penalty-free.⁷ Important catch: this exception belongs to the employer plan, not to IRAs. Roll the money into an IRA and then withdraw it before 59½, and you lose it.⁸ A lot of people trip on this by rolling funds reflexively without thinking about whether they might need early access.

You can also set up substantially equal periodic payments, often called 72(t) payments, calculated over your life expectancy. The payments must continue until the later of five years or age 59½. Modify the schedule before then and the IRS retroactively applies the 10% penalty to every distribution you’ve already taken.⁹ It is a long-term commitment, not a short-term fix.

Total and permanent disability also qualifies, as do distributions to a beneficiary after the participant’s death.⁶ Whichever exception you rely on, you have to claim it on Form 5329 at filing time.¹⁰ If the distribution code on your 1099-R doesn’t already reflect it and you skip Form 5329, the IRS will assess the penalty automatically.

Pension Income Can Make Your Social Security Taxable

A less obvious cost of pension income is that it can drag your Social Security benefits into tax too. The IRS uses “combined income” to decide how much of your Social Security counts as gross income: your adjusted gross income (which includes pension distributions), plus tax-exempt interest, plus half your Social Security benefits.¹¹ The thresholds were never indexed for inflation, so more retirees cross them every year.¹²

Single filers with combined income between $25,000 and $34,000: up to 50% of benefits taxable.
Single filers above $34,000: up to 85% of benefits taxable.
Married filing jointly between $32,000 and $44,000: up to 50% taxable.
Married filing jointly above $44,000: up to 85% taxable.

A pension of $2,500 a month alone puts you at $30,000, which means almost any single filer collecting both a pension and Social Security will have up to 85% of benefits taxed. A lump sum is more punishing still: a $300,000 lump sum in one year effectively guarantees the maximum 85% inclusion that year.

Pension Income Can Raise Your Medicare Premiums

Pension distributions can also increase Medicare costs through the Income-Related Monthly Adjustment Amount, or IRMAA. Medicare looks at your modified adjusted gross income from two years earlier to decide whether to add a surcharge to the standard Part B and Part D premiums. For 2026, the standard Part B premium is $202.90 per month, and surcharges begin above $109,000 for single filers or $218,000 for joint filers.

The surcharges are tiered. At the first tier, a single filer between $109,001 and $137,000 pays roughly $1,148 more per year across Part B and Part D. At the top tier, above $500,000, the annual surcharge exceeds $6,900 per person, and both spouses are hit independently.

A lump-sum pension payout is the most common cause of an unexpected IRMAA spike, and because the lookback is two years, the surcharge arrives in a year when most people have forgotten the distribution. A direct rollover avoids it entirely, since rollover amounts are not included in adjusted gross income.

Required Minimum Distributions

You generally must begin required minimum distributions by April 1 of the year after you turn 73.¹³ For anyone born in 1960 or later, the age is 75.¹⁴

If you’re taking your pension as scheduled monthly annuity payments, you usually satisfy the RMD rules automatically — the pension itself is the distribution. The question only comes alive if you rolled a lump sum into an IRA, because the IRA’s own RMD rules then apply.

Missing an RMD carries a 25% excise tax on the shortfall, dropping to 10% if you fix it within two years.¹³

Survivors and Divorce Don’t Erase the Tax

Pension payments don’t become tax-free when the original participant dies. A surviving spouse under a joint-and-survivor annuity reports the income the same way the retiree did, including continuing any fixed monthly basis exclusion.³ A surviving spouse can also roll a lump-sum death benefit into their own IRA; a non-spouse beneficiary can roll it only into an inherited IRA, and inherited IRA distribution rules then take over.

In divorce, a Qualified Domestic Relations Order can send part of a pension to a former spouse. When it does, the former spouse reports and pays the tax on those payments at their own rate and inherits a proportional share of any after-tax basis.¹⁵ They can also roll the distribution into an IRA. But when a QDRO directs payments to a child, the plan participant, not the child, pays the tax.

Controlling the Withholding on Your Payments

Your plan withholds federal income tax from each periodic payment. You set the amount by filing Form W-4P with the plan.¹⁶ If you never submit one, the plan uses a default rate that often doesn’t match your real tax picture, especially with other income in the mix. Revisit your W-4P after any major change in income, filing status, or deductions.

Lump-sum and other nonperiodic distributions use Form W-4R instead. The mandatory 20% on eligible rollover distributions is a floor you can’t lower, but you can ask for more withheld if you expect to owe more.⁵

State tax is a separate layer. Some states have no income tax; others exempt pension income partially or entirely, with the rules and dollar limits varying widely. Checking your state’s treatment before your first check arrives is the simplest way to avoid a surprise at filing time.

1
Office of the Law Revision Counsel. 26 U.S. Code 402 – Taxability of Beneficiary of Employees Trust
2
Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
3
Internal Revenue Service. Publication 575 – Pension and Annuity Income
4
Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
5
Internal Revenue Service. Topic No. 412, Lump-Sum Distributions
6
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
7
Internal Revenue Service. Topic No. 558, Additional Tax on Early Distributions From Retirement Plans Other Than IRAs
8
Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
9
Internal Revenue Service. Substantially Equal Periodic Payments
10
Internal Revenue Service. About Form 5329, Additional Taxes on Qualified Plans
11
Internal Revenue Service. IRS Reminds Taxpayers Their Social Security Benefits May Be Taxable
12
Office of the Law Revision Counsel. 26 U.S. Code 86 – Social Security and Tier 1 Railroad Retirement Benefits
13
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
14
Internal Revenue Service. Retirement Topics – Required Minimum Distributions (RMDs)
15
Internal Revenue Service. Retirement Topics – QDRO: Qualified Domestic Relations Order
16
Internal Revenue Service. About Form W-4P, Withholding Certificate for Periodic Pension or Annuity Payments