When would a pension be partly taxable?

A pension is partly taxable when it has been funded through employer plans where the employee contributed after-tax money. This is because when an employee makes contributions to a pension plan using after-tax dollars, those contributions are not tax-deductible in the year they are made. As a result, they represent a return of capital when the pension is received. Therefore, only the portion of the pension payments that represent earnings on those contributions is subject to income tax, resulting in partial taxation of the pension.

In contrast, if a pension were funded entirely through pre-tax contributions, it would generally be fully taxable when received, as all contributions and earnings would have been deferred from tax. The point about a pension being completely severed from employment or just reaching retirement age does not directly influence the taxability of the pension itself; rather, it pertains more to when the pension is accessed. Thus, the correct answer is rooted in the tax treatment of after-tax versus pre-tax contributions within pension funding.