What is a Pension Tax?

A pension tax is a tax charged on pension income. Tax codes vary significantly between nations, and the handling of pensions for tax purposes can be quite different. People setting up pensions or getting ready to receive pension payments may want to talk to an accountant to get some specific advice and information about how to handle their pension income most effectively. People who neglect to pay their taxes can be subject to penalty, unless they can show how an innocent mistake was made.

Pensions are established by employers or the government to provide income to people after retirement. They are a form of employee benefit and while payments are made into a pension fund on behalf of employees, they are not taxable, as the employee is not directly using the money. Likewise, earnings in pension funds are not taxed when they occur, as these monies are used to grow the fund, making more money available when employees reach retirement age and start filing claims.

When money is disbursed from a pension plan, it becomes income, and can be considered taxable. Some nations place pension income in a different tax bracket or do not tax earnings below a certain amount. Others may treat it like regular income. The pension tax is the tax owed on pension payments, calculated at the end of the year when people prepare tax returns and submit them to the government. People can offset their tax liability by documenting deductible expenses, such as mortgage interest on home or medical expenses, reducing the amount of pension tax they have to pay.

It is important to make sure a pension is structured properly, as mistakes can result in increased tax liability. Generally, the tax code will grandfather in old pension plans so people don't have to pay more pension tax simply because they are part of an older pension plan. If people want to switch plans, they will be advised to change to a different plan or system, and can transfer their pension without paying pension tax as long as they are changing plans, not taking money out of the pension plan.

Pension plans are one among a family of tools people can use to prepare for retirement. People can also start their own retirement accounts, or a joint account where employee contributions are matched by an employer up to a certain amount. Taxes can be tricky with retirement planning and it is advisable to get detailed information at the start to avoid potentially costly mistakes people may have to make up later.