What does it mean for a taxpayer's pension or annuity when contributions were excluded from gross income?

What does it mean for a taxpayer's pension or annuity when contributions were excluded from gross income?

• A. They can never be taxed.
• B. They may exclude the amounts previously included in income.
• C. The taxpayer must repay the entire distribution.
• D. It is considered part of taxable income.

Answer: (B)

When contributions to a pension or annuity plan were excluded from gross income, it indicates that the taxpayer did not pay taxes on those contributions when they were made. As a result, this means that any distributions received from the pension or annuity may allow the taxpayer to exclude the amounts that were previously contributed from being taxed upon withdrawal. In this case, the taxpayer only pays tax on the earnings generated by those contributions, not on the return of the principal contributions since those were never taxed when initially contributed. This principle aligns with the tax treatment of certain retirement accounts, where contributions can be made pre-tax, leading to taxation only on the earnings when distributed. This method encourages saving for retirement by allowing individuals to postpone tax liabilities until a later date.

When contributions to a pension or annuity plan were excluded from gross income, it indicates that the taxpayer did not pay taxes on those contributions when they were made. As a result, this means that any distributions received from the pension or annuity may allow the taxpayer to exclude the amounts that were previously contributed from being taxed upon withdrawal. In this case, the taxpayer only pays tax on the earnings generated by those contributions, not on the return of the principal contributions since those were never taxed when initially contributed.

This principle aligns with the tax treatment of certain retirement accounts, where contributions can be made pre-tax, leading to taxation only on the earnings when distributed. This method encourages saving for retirement by allowing individuals to postpone tax liabilities until a later date.