The tax deductibility of your pension plan contributions usually depends on the type of program you have. The number of employees covered by traditional pension plans has dramatically declined, from 88 percent in 1975 to 33 percent in 2013, lessening the importance of this issue nationally. However, if you're covered by a pension plan, make sure you know whether your personal contributions are tax-deductible or not to avoid income tax filing problems.
Qualified Vs. Nonqualified Plans
IRS-qualified pension plans offer tax benefits to contributors, whether it is the employer or employee making contributions, or both. In many cases, however, tax deductibility is not an issue, as most contributions are made pre-tax, eliminating the need for tax deductions on your annual return. Your contributions to nonqualified pension plans, such as standard annuities, are not tax deductible, as you contribute after-tax dollars to these plans. Some retirement plans, such as 403(b) programs for nonprofit organizations, offer tax-sheltered annuities, which allow you to contribute pre-tax dollars.
If you're covered by a traditional employer-owned pension plan, you may have few or no options or plan varieties. Should the plan be totally employer funded, you'll not face any tax deductibility questions because you make no direct contributions to these plans. If your pension plan is IRS-qualified, you will be allowed to make tax deductible or pre-tax contributions to the retirement fund. Should your employer offer a 401(k) plan instead of a pension plan, you will have a variety of investment options, and your contributions will be tax-deductible, with taxation deferred until you withdraw funds.
Government and Nonprofit Organizations
Some state and local governments still offer traditional pension plans. In many cases, these plans are completely funded by employers. Many nonprofit organizations also remain committed to classic pension plans, most of which are nonqualified plans, without tax-deductible employee contributions. However, more and more government and nonprofit organizations are switching to 403(b) retirement plans in recent years, which are similar to 401(k) plans and do permit tax-deferred contributions. Because your contributions are made from your salary before federal or state taxes are withheld, no tax deductibility issues exist, as you contribute pre-tax dollars to these plans.
Before committing to pension plan contributions, set your financial retirement goals and objectives. For example, you might be covered by a nonqualified plan, which means your contributions are not tax-deductible, but you may still choose to contribute. Should you project being in a high tax bracket at retirement, you may appreciate withdrawing your pension benefits tax-free. The IRS allows you to roll over retirement contributions to nonqualified plans and Roth IRAs, made with after-tax dollars, free of income taxes. Conversely, if you anticipate a lower tax bracket at retirement, you may prefer to set up a traditional IRA, deducting your contributions up to the allowable annual maximum, instead of making nonqualified pension plan after-tax contributions.
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