I said, "The problem is that your pension - for tax purposes - is $0." It is, because in his case, the taxable value of his $40k pension is $0, because of his disability. For TAX PURPOSES, not in real value.
Taking $5k out in withholding has nothing to do with the taxable amount of the pension distribution. Yes, usually you do withholding when the distribution contains taxable income, but that is not a strict requirement.
As far as his tax return is concerned, that distribution was for $0, even if in cash he received $40k.
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