Federal Employee Retirement Income Versus the Tax Man

You’ve probably heard the Benjamin Franklin once said The only certain things in life are death and taxes. But that doesn’t tell you exactly how much you’ll pay in taxes, so how is your retirement income taxed for federal income tax purposes? Let’s take a look.

Most of your CSRS or FERS pension will be taxable. Because your retirement annuity was already taxed, the payments you receive will not be taxable again. Unfortunately, you receive the annuity spread out over your life expectancy. For a federal employee retiring at age 55, that is 360 months, or 30 years. Each year OPM will send you a form 1099-R, which lists your total annuity, the taxable portion of your annuity, and your total contributions to the retirement fund.

If you die before you have received all of your contributions back, your designated survivor will continue to receive your contributions back tax-free. If you have no survivor, or if your survivor also dies before recouping your contributions, the remaining contributions may be taken as a miscellaneous itemized deduction on the tax return your executor files for the year of your death. The deduction is not subject to the usual 2% floor that is applied to miscellaneous itemized deductions.

If you live past your life expectancy, you will have received all of your contributions back and your entire annuity will be taxable.

Your Traditional TSP is fully taxable because you didn’t pay tax on the money you contributed and it grew tax-free. With the TSP, unlike an IRA, if you retire in the year in which you turn 55 (or later) there will be no early withdrawal penalty assessed for withdrawals. You must begin taking TSP distributions by April 1st of the year after the year in which you turn 70 ½ or April 1st of the year after the year in which you retire if you are age 70 ½ or older when you retire. This is true for both the Traditional and the Roth TSPs. Your Traditional TSP distributions are taxed as you receive them.

The Roth TSP, however, is funded with post-tax income. The growth will be free from federal income tax if the Roth account has been open for at least five years and the individual withdrawing the money is at least 59½ years old. The Roth TSP was just introduced in 2012, so it won’t be until 2017 that Roth TSP accounts will meet the five-year rule.

Up to 85% of your Social Security can be taxable. To determine the portion of your Social Security which is taxable, add together half of your Social Security income, all your taxable income and certain tax-exempt income. The following chart shows how much Social Security might be subject to tax.

Filing Status Income Taxable Social Security
Single Under $25,000 None
Single $25,000 to $34,000 Up to 50%
Single Over $34,000 Up to 85%
Joint Under $32,000 None
Joint $32,000 to $44,000 Up to 50%
Joint Over $44,000 Up to 85%

All of your retirement income is taxed at your rate for ordinary income for federal tax purposes.

States vary widely in their tax treatment of retirement income. Members of NARFE (National Active and Retired Federal Employees Association) have access to detailed information on the state treatment of federal annuities on their website http://www.narfe.org.

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