In February 2009, the Internal Revenue Service (IRS) released new withholding tables that apply to pension plan payments, as well as to wage payments by employers. Plan sponsors and employers were required to implement the new withholding tables no later than April 1, 2009. The new tables reflect the “Making Work Pay Tax Credit,” an earned income tax credit that was part of the economic stimulus bill, the American Recovery and Reinvestment Act.

The new withholding tables apply to all Form W-2 income and pension plan payments, except for certain lump-sum retirement payments that are subject to flat income tax withholding. Nevertheless, pension plan payments are not considered “earned income” and, therefore, are not eligible for the Making Work Pay Tax Credit. As a result, the February 2009 withholding tables may cause pensioners to under-withhold income tax.

The IRS has recently released additional withholding amounts that plan sponsors may adopt to help pensioners avoid potential under-withholding problems. The additional withholding amount tables were announced in IRS Notice 1036-P. Under the optional procedure, additional amounts may be withheld from the pension payment to account for the fact that such payment is not treated as earned income and not eligible for the Making Work Pay Tax Credit. If the additional withholding tables are used, the IRS encourages plan sponsors to contact payees who changed their Form W-4P withholding elections after the February 2009 tables were implemented, to ensure the payee’s withholding intent is properly effected. Plan sponsors are not required to use the additional withholding amount tables and may, instead, continue to use the February 2009 tables.

Many plan sponsors will wish to use the new withholding tables and some have already provided their participants with information regarding the February 2009 change in the withholding tables. If the plan sponsor desires to implement the optional procedure to apply additional withholding, a supplemental communication may be appropriate. Plan sponsors should be aware that the IRS will soon launch an outreach effort to educate pensioners about the withholding tables and the Making Work Pay Tax Credit. Plan sponsors should be prepared for inquiries from participants.