• Federal tax lawstax forms image by Chad McDermott from Fotolia.com
  
  How federal taxes are calculated on pensions and annuities depends on how the account was funded. Payments may be fully or partially taxable and may also be subject to a penalty of 10 percent, depending on when the payments are made. The federal taxes due on pensions and annuities are calculated in the same manner as salaries or wages and may be withheld in the same manner.
  
  

Taxable

• If you did not contribute any money toward your pension or annuity, it will be fully taxable when you start taking withdrawals. This may be the case if your employer completely sponsored the retirement account and did not withhold any part of your salary as payment. If this is the case, regular federal income tax will be due on the total amount as it is paid out.
  
  

Partially Taxable

• On the other hand, if you did contribute to the pension or annuity, it will be partially taxable. Basically, the portion that represents the cost of the pension or annuity, or the amount you paid for it, will not be taxable. However, any amount in addition to this amount will be taxable. There are two methods to calculate a partially taxable pension or annuity, known as the general rule or the simplified method. Which method you use will depend on the when the account was set up.
  
  

Penalties

• Taking distributions from your pension or annuity prior to the age of 59 ½ may result in a penalty of 10 percent in addition to the federal taxes due. The purpose of this is to discourage people from misusing taxably beneficial accounts, such as 401(k) plans, IRAs, pensions and annuities. There are, however, exceptions to this penalty in certain cases. The account may be set up to pay out equal payments over your lifetime, even prior to age 59 ½, and the penalty may not apply.
  
  

Federal Income Tax Withholding

• Pension and annuity payments are subject to federal income tax withholding, which means the applicable taxes may be subtracted from your payments before you receive them. The amount withheld is calculated in the same manner as wages. This ensures the proper taxes are paid in an effort to avoid underpayment penalties.