What is the federal income tax rate on a retirement pension

Additional 10% tax for members under age 59-1/2 who continue working for their IMRF employer
Member contributions to IMRF are tax-deferred as retirement savings. Tax-deferred retirement savings are subject to a 10% early withdrawal tax when taken out of the retirement plan before the recipient is age 59 ½. This early withdrawal tax is in addition to the taxpayer's marginal tax rate.
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There are several exceptions to the 10% early withdrawal tax. One of those exceptions is for lifetime monthly annuity payments, beginning not earlier than age 55 (age 50 for public safety employees). To be eligible for this exception, the taxpayer must have totally separated from service with the employer sponsoring the retirement savings plan.
An IMRF pension is eligible for this exception to the early withdrawal penalty IF the member is no longer working for the IMRF employer in any capacity. If a retired member under age 59 ½ continues to work for the same IMRF employer in a non-qualifying position or in an elected position, the 10% additional tax will apply to each month’s pension payment. The tax will be owed until the member reaches age 59 ½ or leaves employment with the IMRF employer.
Federal Income Tax

IMRF retirement pensions are subject to federal income tax. However, when most members retire, a part of the pension payment they receive represents their own contributions. That is, part of each pension payment is a return of member contributions.

In some cases, the member has already paid income taxes on the money used to make those contributions (”previously taxed contributions”) and in other cases, the member has not paid income taxes on the money used to make those contributions (”tax deferred contributions”).

That part of the pension attributable to previously taxed IMRF member contributions made before the Section 414(h) tax deferral plan are tax exempt, that is, not subject to income taxes. The part attributable to tax-deferred IMRF member contributions (contributions paid under the 414(h) tax deferral plan) and to employer contributions is taxable.

Therefore, for most members who began participation in 1984 or thereafter, the entire pension is taxable.

For those members whose participation began before 1984 (in some cases before 1982) a small part of the pension will be non-taxable.

The taxable portion of each pension payment is computed using the IRS formula ”Simplified General Rule.” This rule is based on the amount of the retiree’s previously taxed contributions and the number of pension payments the retiree and spouse are expected to receive (their joint life expectancy).

This formula provides a dollar amount of each pension payment that is excluded from income for purposes of federal income taxes—that is, not subject to federal income taxes.

IMRF’s Certificate of Benefits (Exhibit 5M-a) provides the amount of the previously taxed contributions as well as the portion of each payment which is excluded from federal income tax (subject to federal income tax) under the Simplified General Rule (a dollar amount).

The taxable amounts of IMRF pensions will vary among retirees.

When previously taxed contributions have been recovered (received by the retiree as part of his or her pension payments), the entire pension will be subject to federal income tax.

Federal Income Tax Reporting and Withholding

Under Section 3405 of the Internal Revenue Code, IMRF must automatically withhold federal income tax according to an IRS withholding schedule if the taxable portion of the monthly pension exceeds a certain dollar amount, unless the retired member elects not to have income tax withheld or to change the amount withheld. (Refer to the Federal Taxes/Social Security Appendix for dollar amounts.)

Note: The dollar amount withheld will change with future changes in income tax rates, personal exemptions, and standard deduction amounts. Refer to Section 9, Appendix A.

If the taxable portion is less than the dollar limit, IMRF withholds tax only if the retiree requests it. A new retiree is sent IRS Form W-4P, ”Withholding Certificate for Pension or Annuity Payments,” to request withholding for federal income tax purposes. Retirees who wish to change their withholding status or amount can get Form W-4P from the Internal Revenue Service or from IMRF.

If the retired member elects not to have tax withheld, IMRF advises the retiree that he or she may need to file quarterly estimated federal income tax returns and deposits in order to avoid tax penalties.

IMRF reports pension payments to the Internal Revenue Service on Form 1099-R. Four copies are sent to the retired member and one is filed with the Internal Revenue Service. For members who retired after 1973, IMRF fills in the box entitled ”Taxable Amount.” For members who retired prior to 1974, IMRF does not determine the taxable amount. However, all of the pension payment or a portion thereof may be subject to tax.

Illinois Income Tax (Illinois Residents Only)

The Illinois Income Tax Act exempts IMRF pension payments from Illinois income tax, that is, IMRF pensions are not subject to Illinois income tax. Therefore, IMRF retirees whose legal residence is in Illinois do not pay state income tax on their IMRF pension.

Because the federally taxable portion of the pension is included in federal adjusted gross income, the federally taxable portion will also be included on Illinois IL-1040. In order to claim the exemption on the Illinois Income Tax Return, it is necessary to follow the specific instructions provided with the IL-1040 in regard to subtractions to arrive at Illinois taxable income.