Q: I understand (and even sort of agree) why the government excludes only a small portion of my pension income from taxes. I am getting that pension for the rest of what I hope to be a long lifetime. My question is if that life is NOT so long; suppose for instance I died this year after being retired for only a little over two years. I have only had taxes excluded on maybe $12-$14K. The remainder of my original $220K contributions are still “in the pot” so to speak. If my wife and I elected no survivor annuity, does she get that remainder without paying additional taxes on it, since it has already been taxed? Same question in the case where there is no spouse and the remainder goes to my estate – is it taxed again even though I have paid taxes on it once?
A: Your beneficiary will not pay taxes on any refund of retirement contributions, as you paid the taxes when you paid them. In your case, where you did not elect a survivor annuity, any contributions remaining at the time of your death will be distributed according to your SF-2808 (Designation of Beneficiary).
But, as you suspected, there is a catch. As I discussed in my article, the IRS views you as recouping your already taxed contributions back little-by-little, based on your life expectancy for tax purposes. OPM, however has different rules when looking at refunds, You are viewed as recouping your contributions dollar for dollar from the beginning for refund purposes. Basically, in OPM’s eyes, you will have recouped contributions in no longer than three years from your retirement.
I agree, it isn’t fair, but it’s the rules.
John Grobe’s latest book, The Answer Book on Your Federal Employee Benefits, has just been released by LRP Publications. Order your copy at shoplrp.com. Ask your human resources office to contact Federal Career Experts about pre-retirement training.