Depends on the Tax. State income tax is sometimes partially non taxable. NY state exempts the first 10k in retirement benefits. The Federal Gov't will tax the benefits as ordinary income in most cases. In cases related to an on the job injury like a police officer or fireman it is usually tax free. Assuming it is reportable and taxable income, you still may not need withholding if you have enough deductions to offset the tax liablity. It's case by case.