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Reduced Annuity: Federal Employee Retirement Taxes (2025 IRS Guide)

This guide covers “Reduced Annuity” within federal employee retirement taxes. The following material presents the IRS treatment of this topic, including the qualifications, exceptions, and examples in the source section. Read the rules alongside the facts of your own situation before deciding what to report, deduct, or document.

Adapted from Publication 721 (2025), Tax Guide to U.S. Civil Service Retirement Benefits, published by the Internal Revenue Service. This guide retains the source edition’s years, amounts, deadlines, and examples. It is guidance for that edition, not a statement that the same figures apply to every tax year.

Context for these rules

If you are eligible, you may choose an alternative form of annuity. If you make this choice, you will receive a lump-sum payment equal to your contributions to the plan and a reduced monthly annuity. You are eligible to make this choice if you meet all of the following requirements.

  • You are retiring, but not on disability.

  • You have a life-threatening illness or other critical medical condition.

  • You don’t have a former spouse entitled to court-ordered benefits based on your service.

If you aren’t eligible or don’t choose this alternative annuity, you can skip the following discussion and go to Federal Gift Tax, later.

Reduced Annuity

If you have chosen to receive a lump-sum payment under the alternative annuity option, you will also receive reduced monthly annuity payments. These annuity payments each will have a tax-free and a taxable part. To figure the tax-free part of each annuity payment, you must use the Simplified Method (Worksheet A). For instructions on how to complete the worksheet, see Worksheet A under Simplified Method, earlier.

To complete Worksheet A, line 2, you must reduce your cost in the plan by the tax-free part of the lump-sum payment you received. Enter as your net cost on line 2 the amount from Worksheet B, line 5. Don’t include the tax-free part of the lump-sum payment with other amounts recovered tax free (Worksheet A, line 6) when limiting your total exclusion to your total cost.

Example.

The facts are the same as in the example for David Brown in the preceding discussion. In addition, David received 10 annuity payments in 2025 of $1,200 each. Using Worksheet A, he figures the taxable part of his annuity payments. He completes line 2 by reducing his $31,000 cost by the $6,200 tax-free part of his lump-sum payment. His entry on line 2 is his $24,800 net cost in the plan (the amount from Worksheet B, line 5). He doesn’t include the tax-free part of his lump-sum payment on Worksheet A, line 6. An example of David’s filled-in Worksheet A is shown in this publication.

Worksheet A. Simplified Method for David Brown

See the instructions under Simplified Method in Part II of this publication.

1. Enter the total pension or annuity payments received this year. Also, add this amount to the total for Form 1040, 1040-SR, or 1040-NR, line 5a 1. $ 12,000
2. Enter your cost in the plan at the annuity starting date, plus any death benefit exclusion.* See Your cost under Rules for Retirees in Part II, earlier 2. 24,800
Note: If your annuity starting date was before 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 (even if the amount of your pension or annuity has changed). 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. 360
4. Divide line 2 by the number on line 3 4. 68.89
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. 688.90
6. Enter any amounts previously recovered tax free in years after 1986. This is the amount shown on line 10 of your worksheet for last year 6. 0
7. Subtract line 6 from line 2 7. 24,800
8. Enter the smaller of line 5 or line 7 8. 688.90
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 or 1040-SR, line 5b. If you are a nonresident alien, enter this amount on line 1 of Worksheet C. If your Form CSA 1099-R or Form CSF 1099-R shows a larger amount, use the amount figured on this line instead. If you are a retired public safety officer, see Distributions Used To Pay Insurance Premiums for Public Safety Officers under Part II before entering an amount on your tax return or Worksheet C, line 1 9. $ 11,311.10
10. Was your annuity starting date before 1987?
worksheet checkbox Yes. stopDon’t complete the rest of this worksheet.

worksheet checkbox No. Add lines 6 and 8. This is the amount you have recovered tax free through 2025. You will need this number if you need to fill out this worksheet next year		 10. 688.90
11. Balance of cost to be recovered. Subtract line 10 from line 2. If zero, you will not have to complete this worksheet next year. The payments you receive next year will generally be fully taxable 11. $ 24,111.10
Table 1 for Line 3 Above
IF your age on your
annuity starting date was... 		AND your annuity starting date was—
before November 19, 1996,
THEN enter on line 3... 		after November 18, 1996,
THEN enter on line 3...
55 or under 300 360
56–60 260 310
61–65 240 260
66–70 170 210
71 or over 120 160

Table 2 for Line 3 Above
IF the annuitants’ combined ages on your annuity starting date were... THEN enter on line 3...
110 or under 410
111–120 360
121–130 310
131–140 260
141 or over 210

* A death benefit exclusion of up to $5,000 applies to certain benefits received by survivors of employees who died before August 21, 1996.

.Reemployment after choosing the alternative annuity option. If you chose this option when you retired and then you were reemployed by the federal government before retiring again, your Form CSA 1099-R may show only the amount of your contributions to your retirement plan during your reemployment. If the amount on the form doesn’t include all your contributions, disregard it and use your total contributions to figure the taxable part of your annuity payments..

Annuity starting date before November 19, 1996.

If your annuity starting date is before November 19, 1996, and you chose the alternative annuity option, the taxable and tax-free parts of your lump-sum payment and your annuity payments are figured using different rules. Under those rules, you don’t reduce your cost in the plan (Worksheet A, line 2) by the tax-free part of the lump-sum payment. However, you must include that tax-free amount with other amounts previously recovered tax free (Worksheet A, line 6) when limiting your total exclusion to your total cost.

Using the guidance

Keep the documents that establish the dates, amounts, and circumstances described above. References to other chapters, forms, worksheets, or earlier and later sections refer to the linked IRS publication. Check the full publication and its updates before relying on a rule for a different tax year or a situation not addressed here.

Sources and further reading

The cited U.S. government text is in the public domain. Source accessed October 28, 2026. Fynoptic has organized this material for educational use and is independent of, and not endorsed by, the IRS.

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