A pension plan is usually a type of retirement plan that gives employer the opportunity to make a contribution to a fund set aside for an employee's future benefit.  The pool of funds is invested on behalf of the employee, on a tax-exempt basis, and is intended to yield a stream of payments to the employee upon retirement. Pension plans can include a variety of types of contributions in addition to cash payments. 

For example, a pension plan may include profit-sharing plan, a stock bonus plan (usually deferred until retirement so that the contribution is taxed at the retirement tax rate) and even an employee stock ownership.

Upon retirement, when one start receiving funds from a qualified pension plan, they may have to pay federal and state income taxes.

If one have no investment in the plan because they have not contributed anything or are considered to not have contributed anything, their employer did not withhold contributions from their salary or one have received all of their contributions (investments in the contract) tax free in previous years, their pension is fully taxable.

 

If one has contributed money after tax was paid, then their pension or annuity is only partially taxable. they don't owe tax on the part of the payment they made that represents the return of the after-tax amount they put into the plan. Partially taxable qualified pensions are taxed under the Simplified Method.

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