10.   Retirement Plans, Pensions, and Annuities

Table of Contents

    * What's New
    * Introduction
          o The General Rule.
          o Civil service retirement benefits.
          o Individual retirement arrangements (IRAs).
    * Useful Items - You may want to see:
    * General Information
          o Tax-free exchange.
          o How To Report
    * Cost (Investment in the Contract)
    * Taxation of Periodic Payments
          o Simplified Method
    * Taxation of Nonperiodic Payments
          o Lump-Sum Distributions
    * Rollovers
    * Special Additional Taxes
          o Tax on Early Distributions
          o Tax on Excess Accumulations
    * Survivors

What's New

Katrina Emergency Tax Relief Act of 2005. This Act provides tax relief for
persons affected by Hurricane Katrina. Under the Act, you may qualify for
tax-favored withdrawals, recontributions, and loans. See Publication 4492.
Introduction

This chapter discusses the tax treatment of distributions you receive from:

    *

      An employee pension or annuity from a qualified plan,
    *

      A disability retirement, and
    *

      A purchased commercial annuity.

What is not covered in this chapter.   The following topics are not
discussed in this chapter.

The General Rule.   This is the method generally used to determine the tax
treatment of pension and annuity income from nonqualified plans (including
commercial annuities). For a qualified plan, you generally cannot use the
General Rule unless your annuity starting date is before November 19, 1996.
For more information about the General Rule, see Publication 939.

Civil service retirement benefits.    If you are retired from the federal
government (either regular or disability retirement), see Publication 721,
Tax Guide to U.S. Civil Service Retirement Benefits. Publication 721 also
covers the information that you need if you are the survivor or beneficiary
of a federal employee or retiree who died.

Individual retirement arrangements (IRAs).   Information on the tax
treatment of amounts you receive from an IRA is in chapter 17.

Useful Items - You may want to see:

Publication

    *

      575 Pension and Annuity Income
    *

      721 Tax Guide to U.S. Civil Service Retirement Benefits
    *

      939 General Rule for Pensions and Annuities

Form (and Instructions)

    *

      W-4P
      Withholding Certificate for Pension or Annuity Payments
    *

      1099-R
      Distributions From Pensions, Annuities, Retirement or Profit-Sharing
Plans, IRAs, Insurance Contracts, etc.
    *

      4972
      Tax on Lump-Sum Distributions
    *

      5329
      Additional Taxes on Qualified Plans (Including IRAs) and Other
Tax-Favored Accounts

General Information
Disability Pensions.   If you retired on disability, you generally must
include in income any disability pension you receive under a plan that is
paid for by your employer. You must report your taxable disability payments
as wages on line 7 of Form 1040 or Form 1040A until you reach minimum
retirement age. Minimum retirement age generally is the age at which you
can first receive a pension or annuity if you are not disabled.

  
Tip
You may be entitled to a tax credit if you were permanently and totally
disabled when you retired. For information on this credit, see chapter 33.

  Beginning on the day after you reach minimum retirement age, payments you
receive are taxable as a pension or annuity. Report the payments on Form
1040, lines 16a and 16b or on Form 1040A, lines 12a and 12b.

  
Tip
Disability payments for injuries incurred as a direct result of a terrorist
attack directed against the United States (or its allies) are not included
in income. For more information about payments to survivors of terrorist
attacks, see Publication 3920, Tax Relief for Victims of Terrorist Attacks.

  For more information on how to report disability pensions, including
military and certain government disability pensions, see chapter 5.

More than one program.   If you receive benefits from more than one program
under a single trust or plan of your employer, such as a pension plan and a
profit-sharing plan, you may have to figure the taxable part of each
separately. Your former employer or the plan administrator should be able
to tell you if you have more than one pension or annuity contract.

Railroad retirement benefits.   Part of the railroad retirement benefits
you receive is treated for tax purposes like social security benefits, and
part is treated like an employee pension. For information about railroad
retirement benefits treated as social security benefits, see Publication
915, Social Security and Equivalent Railroad Retirement Benefits. For
information about railroad retirement benefits treated as an employee
pension, see Railroad Retirement in Publication 575.

Credit for the elderly or the disabled.   If you receive a pension or
annuity, you may be able to take the credit for the elderly or the
disabled. See chapter 33.

Withholding and estimated tax.   The payer of your pension, profit-sharing,
stock bonus, annuity, or deferred compensation plan will withhold income
tax on the taxable parts of amounts paid to you. You can choose not to have
tax withheld unless they are eligible rollover distributions. See Eligible
rollover distributions under Rollovers, later. You make this choice by
filing Form W-4P.

   For payments other than eligible rollover distributions, you can tell
the payer how to withhold by filing Form W-4P. If you receive an eligible
rollover distribution, 20% will generally be withheld. There is no
withholding on a direct rollover of an eligible rollover distribution. See
Direct rollover option under Rollovers, later. If you choose not to have
tax withheld or you do not have enough tax withheld, you may have to pay
estimated tax.

  For more information, see Pensions and Annuities under Withholding in
chapter 4.

Loans.   If you borrow money from your qualified pension or annuity plan,
tax-sheltered annuity program, government plan, or contract purchased under
any of these plans, you may have to treat the loan as a nonperiodic
distribution unless certain exceptions apply. This means that you must
include in income all or part of the amount borrowed. Even if you do not
have to treat the loan as a nonperiodic distribution, you may not be able
to deduct the interest on the loan in some situations. For details, see
Loans Treated as Distributions in Publication 575. For information on the
deductibility of interest, see chapter 23.

Qualified plans for self-employed individuals.   Qualified plans set up by
self-employed individuals are sometimes called Keogh or H.R. 10 plans.
Qualified plans can be set up by sole proprietors, partnerships (but not a
partner), and corporations. They can cover self-employed persons, such as
the sole proprietor or partners, as well as regular (common-law) employees.

   Distributions from a qualified plan are usually fully taxable because
most recipients have no cost basis. If you have an investment (cost) in the
plan, however, your pension or annuity payments from a qualified plan are
taxed under the Simplified Method. For more information about qualified
plans, see Publication 560, Retirement Plans for Small Business.

Section 457 deferred compensation plans.    If you work for a state or
local government or for a tax-exempt organization, you may be able to
participate in a section 457 deferred compensation plan. If your plan is an
eligible plan, you are not taxed currently on pay that is deferred under
the plan or on any earnings from the plan's investment of the deferred pay.
You are taxed on amounts deferred in an eligible state or local government
plan only when they are distributed from the plan. You are taxed on amounts
deferred in an eligible tax-exempt organization plan when they are
distributed or otherwise made available to you.

  This chapter covers the tax treatment of benefits under eligible section
457 plans, but it does not cover the treatment of deferrals. For
information on deferrals under section 457 plans, see Retirement Plan
Contributions under Employee Compensation in Publication 525.

  For general information on these deferred compensation plans, see Section
457 Deferred Compensation Plans in Publication 575.

Purchased Annuities.   If you receive pension or annuity payments from a
privately purchased annuity contract from a commercial organization, such
as an insurance company, you generally must use the General Rule to figure
the tax-free part of each annuity payment. For more information about the
General Rule, get Publication 939. Also, see Variable Annuities in
Publication 575 for the special provisions that apply to these annuity
contracts.

Tax-free exchange.   You do not recognize gain or loss on an exchange of an
annuity contract for another annuity contract if the insured or annuitant
remains the same. However, if an annuity contract is exchanged for a life
insurance or endowment contract, any gain due to interest accumulated on
the contract is ordinary income. See Transfers of Annuity Contracts in
Publication 575 for more information about exchanges of annuity contracts.

How To Report

If you file Form 1040, report your total annuity on line 16a and the
taxable part on line 16b. If your pension or annuity is fully taxable,
enter it on line 16b; do not make an entry on line 16a.

If you file Form 1040A, report your total annuity on line 12a and the
taxable part on line 12b. If your pension or annuity is fully taxable,
enter it on line 12b; do not make an entry on line 12a.
More than one annuity.   If you receive more than one annuity and at least
one of them is not fully taxable, enter the total amount received from all
annuities on Form 1040, line 16a or Form 1040A, line 12a, and enter the
taxable part on Form 1040, line 16b, or Form 1040A, line 12b. If all the
annuities you receive are fully taxable, enter the total of all of them on
Form 1040, line 16b, or Form 1040A, line 12b.

Joint return.   If you file a joint return and you and your spouse each
receive one or more pensions or annuities, report the total of the pensions
and annuities on Form 1040, line 16a, or Form 1040A, line 12a, and report
the taxable part on Form 1040, line 16b, or Form 1040A, line 12b.

Cost (Investment in the Contract)

Before you can figure how much, if any, of a distribution from your pension
or annuity plan is taxable, you must determine your cost (your investment
in the contract) in the pension or annuity. Your total cost in the plan
includes everything that you paid. It also includes amounts your employer
paid that were taxable to you when paid. Cost does not include any amounts
you deducted or excluded from income.

From this total cost, subtract any refunds of premiums, rebates, dividends,
unrepaid loans, or other tax-free amounts you received by the later of the
annuity starting date or the date on which you received your first payment.

Your annuity starting date is the later of the first day of the first
period for which you received a payment, or the date the plan's obligations
became fixed.
Foreign employment contributions.   If you worked in a foreign country and
contributions were made to your retirement plan, special rules apply in
determining your cost. See Publication 575.

Taxation of Periodic Payments
Fully taxable payments.   Generally, if you did not pay any part of the
cost of your employee pension or annuity and your employer did not withhold
part of the cost from your pay while you worked, the amounts you receive
each year are fully taxable. You must report them on your income tax return.

Partly taxable payments.   If you paid part of the cost of your annuity,
you are not taxed on the part of the annuity you receive that represents a
return of your cost. The rest of the amount you receive is taxable. Your
annuity starting date determines which method you must or may use.

  If you contributed to your pension or annuity plan, you figure the
tax-free and the taxable parts of your annuity payments under either the
Simplified Method or the General Rule. If your annuity starting date is
after November 18, 1996, and your payments are from a qualified plan, you
must use the Simplified Method. Generally, you must use the General Rule
only for nonqualified plans.

  If your annuity is paid under a qualified plan and your annuity starting
date is after July 1, 1986 and before November 19, 1996, you could have
chosen to use either the General Rule or the Simplified Method.

Simplified Method

Under the Simplified Method, you figure the tax-free part of each annuity
payment by dividing your cost by the total number of anticipated monthly
payments. For an annuity that is payable for the lives of the annuitants,
this number is based on the annuitants' ages on the annuity starting date
and is determined from a table. For any other annuity, this number is the
number of monthly annuity payments under the contract.
Who must use the Simplified Method.   You must use the Simplified Method if
your annuity starting date is after November 18, 1996, and you receive
pension or annuity payments from a qualified plan or annuity, unless you
were at least 75 years old and entitled to annuity payments from a
qualified plan that are guaranteed for 5 years or more.

Guaranteed payments.   Your annuity contract provides guaranteed payments
if a minimum number of payments or a minimum amount (for example, the
amount of your investment) is payable even if you and any survivor
annuitant do not live to receive the minimum. If the minimum amount is less
than the total amount of the payments you are to receive, barring death,
during the first 5 years after payments begin (figured by ignoring any
payment increases), you are entitled to less than 5 years of guaranteed
payments.

Who must use the General Rule.   You must use the General Rule if you
receive pension or annuity payments from:

    *

      A nonqualified plan (such as a private annuity, a purchased
commercial annuity, or a nonqualified employee plan), or
    *

      A qualified plan if you are age 75 or older on your annuity starting
date and your annuity payments are guaranteed for at least 5 years.

Annuity starting before November 19, 1996.   If your annuity starting date
is after July 1, 1986, and before November 19, 1996, you had to use the
General Rule for either circumstance described above. You also had to use
it for any fixed-period annuity. If you did not have to use the General
Rule, you could have chosen to use it. If your annuity starting date is
before July 2, 1986, you had to use the General Rule unless you could use
the Three-Year Rule.

  If you had to use the General Rule (or chose to use it), you must
continue to use it each year that you recover your cost.

Who cannot use the General Rule.   You cannot use the General Rule if you
receive your pension or annuity from a qualified plan and none of the
circumstances described in the preceding discussions apply to you. See Who
must use the Simplified Method, earlier.

More information.   For complete information on using the General Rule,
including the actuarial tables you need, see Publication 939.

Exclusion limit.   Your annuity starting date determines the total amount
that you can exclude from your taxable income over the years.

Exclusion limited to cost.   If your annuity starting date is after 1986,
the total amount of annuity income that you can exclude over the years as a
recovery of the cost cannot exceed your total cost. Any unrecovered cost at
your (or the last annuitant's) death is allowed as a miscellaneous itemized
deduction on the final return of the decedent. This deduction is not
subject to the 2%-of-adjusted-gross-income limit.

Exclusion not limited to cost.   If your annuity starting date is before
1987, you can continue to take your monthly exclusion for as long as you
receive your annuity. If you chose a joint and survivor annuity, your
survivor can continue to take the survivor's exclusion figured as of the
annuity starting date. The total exclusion may be more than your cost.

How to use the Simplified Method.    Complete the Simplified Method
Worksheet in Publication 575 to figure your taxable annuity for 2005. If
the annuity is payable only over your life, use your age at the annuity
starting date to determine the total number of expected monthly payments
for your annuity. For annuity starting dates beginning in 1998, if your
annuity is payable over your life and the lives of other individuals, use
the combined ages of you and the youngest survivor annuitant at the annuity
starting date. However, if your annuity starting date began before January
1, 1998, the total number of monthly annuity payments expected to be
received is based on the primary annuitant's age at the annuity starting date.

  
Tip
Be sure to keep a copy of the completed worksheet; it will help you figure
your taxable annuity in later years.

Example.

Bill Smith, age 65, began receiving retirement benefits in 2005, under a
joint and survivor annuity. Bill's annuity starting date is January 1,
2005. The benefits are to be paid for the joint lives of Bill and his wife
Kathy, age 65. Bill had contributed $31,000 to a qualified plan and had
received no distributions before the annuity starting date. Bill is to
receive a retirement benefit of $1,200 a month, and Kathy is to receive a
monthly survivor benefit of $600 upon Bill's death.

Bill must use the Simplified Method to figure his taxable annuity because
his payments are from a qualified plan and he is under age 75. Because his
annuity is payable over the lives of more than one annuitant, he uses his
and Kathy's combined ages and Table 2 at the bottom of the worksheet in
completing line 3 of the worksheet. His completed worksheet is shown in
Worksheet 10-A.

Bill's tax-free monthly amount is $100 ($31,000 ÷ 310 as shown on line 4 of
the worksheet). Upon Bill's death, if Bill has not recovered the full
$31,000 investment, Kathy will also exclude $100 from her $600 monthly
payment. The full amount of any annuity payments received after 310
payments are paid must be included in gross income.

If Bill and Kathy die before 310 payments are made, a miscellaneous
itemized deduction will be allowed for the unrecovered cost on the final
income tax return of the last to die. This deduction is not subject to the
2%-of-adjusted gross-income limit.
  
Tip
Had Bill's retirement annuity payments been from a nonqualified plan, he
would have used the General Rule. He uses the Simplified Method Worksheet
because his annuity payments are from a qualified plan.

Worksheet 10-A. Simplified Method Worksheet for Bill Smith
1. 	Enter the total pension or annuity payments received this year. Also,
add this amount to the total for Form 1040, line 16a, or Form 1040A, line
12a 	1. 	14,400
2. 	Enter your cost in the plan (contract) at the annuity starting date 
2. 	31,000 	  	 
  	Note: If your annuity starting date wasbefore this year and you
completed this worksheet last year, skip line 3 and enter the amount from
line 4 of last year's worksheet on line 4 below. Otherwise, go to line
3. 	  	  	  	 
3. 	Enter the appropriate number from Table 1 below. But if your annuity
starting date was after 1997 and the payments are for your life and that of
your beneficiary, enter the appropriate number from Table 2 below 	3. 
310 	  	 
4. 	Divide line 2 by the number on line 3 	4. 	100 	  	 
5. 	Multiply line 4 by the number of months for which this year's payments
were made. If your annuity starting date was before 1987, enter this amount
on line 8 below and skip lines 6, 7, 10, and 11. Otherwise, go to line
6 	5. 	1,200 	  	 
6. 	Enter any amounts previously recovered tax free in years after 1986 
6. 	-0- 	  	 
7. 	Subtract line 6 from line 2 	7. 	31,000 	  	 
8. 	Enter the smaller of line 5 or line 7 	8. 	1,200
9. 	Taxable amount for year. Subtract line 8 from line 1. Enter the result,
but not less than zero. Also, add this amount to the total for Form 1040,
line 16b, or Form 1040A, line 12b. 	9. 	13,200
  	Note: If your Form 1099-R shows a larger taxable amount, use the amount
on line 9 instead. 	  	 
10. 	Add lines 6 and 8 	10. 	1,200
11. 	Balance of cost to be recovered. Subtract line 10 from line 2 	11. 	29,800
TABLE 1 FOR LINE 3 ABOVE
  	AND your annuity starting date was—
IF the age at annuity
starting date was... 	before November 19,
1996, enter on line 3... 	after November 18,
1996, enter on line 3...
55 or under 	300 	360
56-60 	260 	310
61-65 	240 	260
66-70 	170 	210
71 or older 	120 	160
TABLE 2 FOR LINE 3 ABOVE
IF the combined ages
at annuity starting
date were... 	  	THEN enter
on line 3...
110 or under 	  	410
111-120 	  	360
121-130 	  	310
131-140 	  	260
141 or older 	  	210
Taxation of Nonperiodic Payments

Nonperiodic distributions are also known as amounts not received as an
annuity. They include all payments other than periodic payments and
corrective distributions.
Corrective distributions of excess plan contributions.   If the
contributions made for you during the year to certain retirement plans
exceed certain limits, the excess is taxable to you. To correct an excess,
your plan may distribute it to you (along with any income earned on the
excess). For information on plan contribution limits and how to report
corrective distributions of excess contributions, see Retirement Plan
Contributions under Employee Compensation in Publication 525.

Figuring the taxable amount of nonperiodic payments.   How you figure the
taxable amount of a nonperiodic distribution depends on whether it is made
before the annuity starting date or on or after the annuity starting date.
The annuity starting date is either the first day of the first period for
which you receive an annuity payment under the contract or the date on
which the obligation under the contract becomes fixed, whichever is later.
If it is made before the annuity starting date, its tax treatment also
depends on whether it is made under a qualified or nonqualified plan and,
if it is made under a nonqualified plan, whether it fully discharges the
contract or is allocable to an investment you made before August 14, 1982.

  If you receive a nonperiodic payment from your annuity contract on or
after the annuity starting date, you generally must include all of the
payment in gross income.

  If you receive a nonperiodic distribution before the annuity starting
date from a qualified retirement plan, you generally can allocate only part
of it to the cost of the contract. You exclude from your gross income the
part that you allocate to the cost. You include the remainder in your gross
income.

  If you receive a nonperiodic distribution before the annuity starting
date from a plan other than a qualified retirement plan, it is generally
allocated first to earnings (the taxable part) and then to the cost of the
contract (the tax-free part). This allocation rule applies, for example, to
a commercial annuity contract you bought directly from the issuer.

  For more information, see Figuring the Taxable Amount, under Taxation of
Nonperiodic Payments, in Publication 575.

Lump-Sum Distributions

A lump-sum distribution is the distribution or payment in one tax year of a
plan participant's entire balance from all of the employer's qualified
plans of one kind (for example, pension, profit-sharing, or stock bonus
plans). A distribution from a nonqualified plan (such as a privately
purchased commercial annuity or a section 457 deferred compensation plan of
a state or local government or tax-exempt organization) cannot qualify as a
lump-sum distribution.

The participant's entire balance from a plan does not include certain
forfeited amounts. It also does not include any deductible voluntary
employee contributions allowed by the plan after 1981 and before 1987. For
more information about distributions that do not qualify as lump-sum
distributions, see Distributions that do not qualify under Lump-Sum
Distributions in Publication 575.

If you receive a lump-sum distribution from a qualified employee plan or
qualified employee annuity and the plan participant was born before January
2, 1936, you may be able to elect optional methods of figuring the tax on
the distribution. The part from active participation in the plan before
1974 may qualify as capital gain subject to a 20% tax rate. The part from
participation after 1973 (and any part from participation before 1974 that
you do not report as capital gain) is ordinary income. You may be able to
use the 10-year tax option, discussed later, to figure tax on the ordinary
income part.

Use Form 4972 to figure the separate tax on a lump-sum distribution using
the optional methods. The tax figured on Form 4972 is added to the regular
tax figured on your other income. This may result in a smaller tax than you
would pay by including the taxable amount of the distribution as ordinary
income in figuring your regular tax.
How to treat the distribution.   If you receive a lump-sum distribution,
you may have the following options for how you treat the taxable part.

    *

      Report the part of the distribution from participation before 1974 as
a capital gain (if you qualify) and the part from participation after 1973
as ordinary income.
    *

      Report the part of the distribution from participation before 1974 as
a capital gain (if you qualify) and use the 10-year tax option to figure
the tax on the part from participation after 1973 (if you qualify).
    *

      Use the 10-year tax option to figure the tax on the total taxable
amount (if you qualify).
    *

      Roll over all or part of the distribution. See Rollovers, later. No
tax is currently due on the part rolled over. Report any part not rolled
over as ordinary income.
    *

      Report the entire taxable part of the distribution as ordinary income
on your tax return.

  The first three options are explained in the following discussions.

Electing optional lump-sum treatment.   You can choose to use the 10-year
tax option or capital gain treatment only once after 1986 for any plan
participant. If you make this choice, you cannot use either of these
optional treatments for any future distributions for the participant.

Taxable and tax-free parts of the distribution.    The taxable part of a
lump-sum distribution is the employer's contributions and income earned on
your account. You may recover your cost in the lump sum and any net
unrealized appreciation (NUA) in employer securities tax free.

Cost.   In general, your cost is the total of:

    *

      The plan participant's nondeductible contributions to the plan,
    *

      The plan participant's taxable costs of any life insurance contract
distributed,
    *

      Any employer contributions that were taxable to the plan participant, and
    *

      Repayments of any loans that were taxable to the plan participant.

You must reduce this cost by amounts previously distributed tax free.

Net unrealized appreciation (NUA).   The NUA in employer securities (box 6
of Form 1099-R) received as part of a lump-sum distribution is generally
tax free until you sell or exchange the securities. (For more information,
see Distributions of employer securities under Taxation of Nonperiodic
Payments in Publication 575.)

Capital Gain Treatment

Capital gain treatment applies only to the taxable part of a lump-sum
distribution resulting from participation in the plan before 1974. The
amount treated as capital gain is taxed at a 20% rate. You can elect this
treatment only once for any plan participant, and only if the plan
participant was born before January 2, 1936.

Complete Part II of Form 4972 to choose the 20% capital gain election. For
more information, see Capital Gain Treatment under Lump-Sum Distributions
in Publication 575.
10-Year Tax Option

The 10-year tax option is a special formula used to figure a separate tax
on the ordinary income part of a lump-sum distribution. You pay the tax
only once, for the year in which you receive the distribution, not over the
next 10 years. You can elect this treatment only once for any plan
participant, and only if the plan participant was born before January 2, 1936.

The ordinary income part of the distribution is the amount shown in box 2a
of the Form 1099-R given to you by the payer, minus the amount, if any,
shown in box 3. You also can treat the capital gain part of the
distribution (box 3 of Form 1099-R) as ordinary income for the 10-year tax
option if you do not choose capital gain treatment for that part.

Complete Part III of Form 4972 to choose the 10-year tax option. You must
use the special tax rates shown in the instructions for Part III to figure
the tax. Publication 575 illustrates how to complete Form 4972 to figure
the separate tax.
Rollovers

If you withdraw cash or other assets from a qualified retirement plan in an
eligible rollover distribution, you can defer tax on the distribution by
rolling it over to another qualified retirement plan or a traditional IRA.

For this purpose, the following plans are qualified retirement plans.

    *

      A qualified employee plan.
    *

      A qualified employee annuity.
    *

      A tax-sheltered annuity plan (403(b) plan).
    *

      An eligible state or local government section 457 deferred
compensation plan.

Time for making rollover.   You generally must complete the rollover by the
60th day following the day on which you receive the distribution from your
employer's plan. (This 60-day period is extended for the period during
which the distribution is in a frozen deposit in a financial institution.)
For all rollovers to an IRA, you must irrevocably elect rollover treatment
by written notice to the trustee or issuer of the IRA.

Tip
The IRS may waive the 60-day requirement where the failure to do so would
be against equity or good conscience, such as in the event of a casualty,
disaster, or other event beyond your reasonable control.
Eligible rollover distributions.   Generally, an eligible rollover
distribution is any distribution of all or the balance to your credit in a
qualified retirement plan. For information about exceptions to eligible
rollover distributions, see Publication 575.

Rollover of nontaxable amounts.   You may be able to roll over the
nontaxable part of a distribution (such as your after-tax contributions)
made to another qualified retirement plan or traditional IRA. The transfer
must be made either through a direct rollover to a qualified plan that
separately accounts for the taxable and nontaxable parts of the rollover or
through a rollover to a traditional IRA.

  If you roll over only part of a distribution that includes both taxable
and nontaxable amounts, the amount you roll over is treated as coming first
from the taxable part of the distribution.

Direct rollover option.   You can choose to have any part or all of an
eligible rollover distribution paid directly to another qualified plan (if
permitted) or to a traditional IRA. If you decide on a rollover, it is
generally to your advantage to choose this direct rollover option. Under
this option, the plan administrator would not withhold tax from any part of
the distribution that is directly paid to the other plan.

Withholding tax.   If you choose to have all or any part of the
distribution paid to you, it is taxable in the year distributed unless you
roll it over to another qualified plan or to a traditional IRA within 60
days. The plan administrator must withhold income tax of 20% from the
amount of the distribution paid to you. (See Pensions and Annuities under
Withholding in chapter 4.)

  
Caution
If you decide to roll over an amount equal to the distribution before
withholding, your contribution to the new plan or IRA must include other
money (for example, from savings or amounts borrowed) to replace the amount
withheld.

  The administrator must give you a written explanation of your
distribution options within a reasonable period of time before making an
eligible rollover distribution.

Rollover by surviving spouse.   You may be able to roll over tax free all
or part of a distribution from a qualified retirement plan you receive as
the surviving spouse of a deceased employee. The rollover rules apply to
you as if you were the employee. You can roll over a distribution into a
qualified retirement plan or a traditional IRA.

   A beneficiary other than the employee's surviving spouse cannot roll
over a distribution.

Alternate payee under qualified domestic relations order.   You may be able
to roll over tax free all or part of a distribution from a qualified
retirement plan that you receive under a qualified domestic relations order
(QDRO). If you receive the distribution as an employee's spouse or former
spouse (not as a nonspousal beneficiary), the rollover rules apply to you
as if you were the employee. You can roll over the distribution from the
plan into a traditional IRA or to another eligible retirement plan. See
Publication 575 for more information on benefits received under a QDRO.

Retirement bonds.   If you redeem a retirement bond purchased under a
qualified bond purchase plan, you can defer the tax on the amount received
that exceeds your basis by rolling it over to an IRA or qualified employer
plan as discussed in Publication 590.

Special Additional Taxes

To discourage the use of pension funds for purposes other than normal
retirement, the law imposes additional taxes on early distributions of
those funds and on failures to withdraw the funds timely. Ordinarily, you
will not be subject to these taxes if you roll over all early distributions
you receive, as explained earlier, and begin drawing out the funds at a
normal retirement age, in reasonable amounts over your life expectancy.
These special additional taxes are the taxes on:

    *

      Early distributions, and
    *

      Excess accumulation (not receiving minimum distributions).

These taxes are discussed in the following sections.

If you must pay either of these taxes, report them on Form 5329. However,
you do not have to file Form 5329 if you owe only the tax on early
distributions and your Form 1099-R correctly shows a “1” in box 7. Instead,
enter 10% of the taxable part of the distribution on Form 1040, line 60 and
write “No” under the heading “Other Taxes” to the left of line 60.

Even if you do not owe any of these taxes, you may have to complete Form
5329 and attach it to your Form 1040. This applies if you meet an exception
to the tax on early distributions but box 7 of your Form 1099-R does not
indicate an exception.
Tax on Early Distributions

Most distributions (both periodic and nonperiodic) from qualified
retirement plans and nonqualified annuity contracts made to you before you
reach age 59½ are subject to an additional tax of 10%. This tax applies to
the part of the distribution that you must include in gross income.

For this purpose, a qualified retirement plan is:

    *

      A qualified employee plan,
    *

      A qualified employee annuity plan,
    *

      A tax-sheltered annuity plan, or
    *

      An eligible state or local government section 457 deferred
compensation plan (to the extent that any distribution is attributable to
amounts the plan received in a direct transfer or rollover from one of the
other plans listed here).

5% rate on certain early distributions from deferred annuity contracts.  
If an early withdrawal from a deferred annuity is otherwise subject to the
10% additional tax, a 5% rate may apply instead. A 5% rate applies to
distributions under a written election providing a specific schedule for
the distribution of your interest in the contract if, as of March 1, 1986,
you had begun receiving payments under the election. On line 4 of Form
5329, multiply by 5% instead of 10%. Attach an explanation to your return.

Exceptions to tax.    Certain early distributions are excepted from the
early distribution tax. If the payer knows that an exception applies to
your early distribution, distribution code “2,” “3,” or “4” should be shown
in box 7 of your Form 1099-R and you do not have to report the distribution
on Form 5329. If an exception applies but distribution code “1” (early
distribution, no known exception) is shown in box 7, you must file Form
5329. Enter the taxable amount of the distribution shown in box 2a of your
Form 1099-R on line 1 of Form 5329. On line 2, enter the amount that can be
excluded and the exception number shown in the Form 5329 instructions.

  
Tip
If distribution code “1” is incorrectly shown on your Form 1099-R for a
distribution received when you were age 59½ or older, include that
distribution on Form 5329. Enter exception number “11” on line 2.

General exceptions.   The tax does not apply to distributions that are:

    *

      Made as part of a series of substantially equal periodic payments
(made at least annually) for your life (or life expectancy) or the joint
lives (or joint life expectancies) of you and your designated beneficiary
(if from a qualified retirement plan, the payments must begin after your
separation from service),
    *

      Made because you are totally and permanently disabled, or
    *

      Made on or after the death of the plan participant or contract holder.

Additional exceptions for qualified retirement plans.   The tax does not
apply to distributions that are:

    *

      From a qualified retirement plan (other than an IRA) if you separated
from service in or after the year you reached age 55,
    *

      From a qualified retirement plan (other than an IRA) to an alternate
payee under a qualified domestic relations order,
    *

      From a qualified retirement plan to the extent you have deductible
medical expenses (medical expenses that exceed 7.5% of your adjusted gross
income), whether or not you itemize your deductions for the year,
    *

      From an employer plan under a written election that provides a
specific schedule for distribution of your entire interest if, as of March
1, 1986, you had separated from service and had begun receiving payments
under the election,
    *

      From an employee stock ownership plan for dividends on employer
securities held by the plan, or
    *

      From a qualified retirement plan due to an IRS levy of the plan.

Additional exceptions for nonqualified annuity contracts.   The tax does
not apply to distributions that are:

    *

      From a deferred annuity contract to the extent allocable to
investment in the contract before August 14, 1982,
    *

      From a deferred annuity contract under a qualified personal injury
settlement,
    *

      From a deferred annuity contract purchased by your employer upon
termination of a qualified employee plan or qualified employee annuity plan
and held by your employer until your separation from service, or
    *

      From an immediate annuity contract (a single premium contract
providing substantially equal annuity payments that start within one year
from the date of purchase and are paid at least annually).

Tax on Excess Accumulations

To make sure that most of your retirement benefits are paid to you during
your lifetime, rather than to your beneficiaries after your death, the
payments that you receive from qualified retirement plans must begin no
later than your required beginning date (defined next). The payments each
year cannot be less than the minimum required distribution.
Required beginning date.   Unless the rule for 5% owners applies, you must
begin to receive distributions from your qualified retirement plan by April
1 of the year that follows the later of:

    *

      The calendar year in which you reach age 70½, or
    *

      The calendar year in which you retire from employment with the
employer maintaining the plan.

However, your plan may require you to begin to receive distributions by
April 1 of the year that follows the year in which you reach age 701/, even
if you have not retired.

For this purpose, a qualified retirement plan includes a:

   1.

      Qualified employee plan,
   2.

      Qualified employee annuity plan,
   3.

      Section 457 deferred compensation plan, or
   4.

      Tax-sheltered annuity plan (for benefits accruing after 1986).

Age 70½.   You reach age 70½ on the date that is 6 calendar months after
the date of your 70th birthday.

  For example, if you are retired and your 70th birthday was on June 30,
2005, you were age 70½ on December 30, 2005. If your 70th birthday was on
July 1, 2005, you reached age 70½ on January 1, 2006.

5% owners.   If you are a 5% owner of the company maintaining your
qualified retirement plan, you must begin to receive distributions by April
1 of the calendar year that follows the year in which you reach age 70½,
regardless of when you retire.

Required distributions.   By the required beginning date, as explained
earlier, you must either:

    *

      Receive your entire interest in the plan (for a tax-sheltered
annuity, your entire benefit accruing after 1986), or
    *

      Begin receiving periodic distributions in annual amounts calculated
to distribute your entire interest (for a tax-sheltered annuity, your
entire benefit accruing after 1986) over your life or life expectancy or
over the joint lives or joint life expectancies of you and a designated
beneficiary (or over a shorter period).

Additional information.   For more information on this rule, see Tax on
Excess Accumulation in Publication 575.

Required distributions not made.   If the actual distributions to you in
any year are less than the minimum required distribution, you are subject
to an additional excise tax. The tax equals 50% of the part of the minimum
required distribution that was not distributed. You can get this excise tax
waived if you establish that the shortfall in distributions was due to
reasonable error and that you are taking reasonable steps to remedy the
shortfall.

State insurer delinquency proceedings.   You might not receive the minimum
distribution because of state insurer delinquency proceedings for an
insurance company. If your payments are reduced below the minimum due to
these proceedings, you should contact your plan administrator. Under
certain conditions, you will not have to pay the excise tax.

Form 5329.   You must file a Form 5329 if you owe a tax because you did not
receive a minimum required distribution from your qualified retirement plan.

Survivors

If you receive a survivor annuity because of the death of a retiree who had
reported the annuity under the Three-Year Rule, include the total received
in income.

If the retiree was reporting the annuity payments under the General Rule,
you must apply the same exclusion percentage to your initial survivor
annuity payment called for in the contract. The resulting tax-free amount
will then remain fixed for future payments. Any increases in the survivor
annuity are fully taxable.

If the retiree was reporting the annuity payments under the Simplified
Method, the part of each payment that is tax free is the same as the
tax-free amount figured by the retiree at the annuity starting date. See
Simplified Method, earlier.

If you are the survivor of an employee, or former employee, who died before
becoming entitled to any annuity payments, you must figure the taxable and
tax-free parts of your annuity payments using the method that applies as if
you were the employee.
Estate tax.   If your annuity was a joint and survivor annuity that was
included in the decedent's estate, an estate tax may have been paid on it.
You can deduct, as a miscellaneous itemized deduction, the part of the
total estate tax that was based on the annuity. This deduction is not
subject to the 2%-of-adjusted gross-income limit. The deceased annuitant
must have died after the annuity starting date. (For details, see section
1.691(d)-1 of the regulations.) This amount cannot be deducted in one year.
It must be deducted in equal amounts over your remaining life expectancy.

  If the decedent died before the annuity starting date of a deferred
annuity contract and you receive a death benefit under that contract, the
amount you receive (either in a lump sum or as periodic payments) in excess
of the decedent's cost is included in your gross income as income in
respect of a decedent for which you may be able to claim an estate tax
deduction.

  See Publication 559, Survivors, Executors, and Administrators, for more
information on the estate tax deduction.