When a federal employee has retired, income taxes do not go away, they just change somewhat. Federal pensions, Social Security and distributions from the Thrift Savings Plan are all taxable to some extent.
The only taxes that do not follow federal employees into retirement are payroll taxes. Payroll taxes are taxes you pay out of earnings in order to fund future benefits. Social Security tax (6.2%) and Medicare tax (1.45%) are only taken out of gross wages and net self-employment income (with a few exceptions, most notably for farmers). In addition, a retiree will not be making contributions for their pension. FERS pension contributions are 0.8% for most employees and 1.3% for special category employees such as law enforcement officers, firefighters, etc. CSRS pension contributions are 7% for most employees and 7.5% for special category employees. CSRS Offset pension contributions are the same as for FERS employees. Employees hired after 01/01/2013 have larger pension contributions, but none of them will be retiring soon, so we will not deal with that here. Retirees are not allowed to contribute to the Thrift Savings Plan.
For federal income tax purposes all of our retirement income is taxed as ordinary income; that is, the percentage we pay in federal income tax is based on the marginal tax bracket where the income falls.
As a federal employee, you are contributing to your pension (CSRS or FERS) out of already taxed dollars. You will not be double taxed on your contributions. You will be taxed on the government’s untaxed contributions, as well as on the earnings that accrue on both your contributions and the government’s contributions.
How much does the government contribute towards your pension? For CSRS the government contributes as much as you do (7% or 7.5%). For CSRS Offset and FERS the government contributes at a different rate each year (based on Treasury returns). In 2014, the government contributed 13.9% and in 2015 they will be contributing 13.2%.
For tax purposes, you are viewed as recouping your already taxed contributions bit-by-bit over your life expectancy. This means that the vast majority of your pension will be subject to federal income tax. The only thing that could be considered good news about this is that OPM calculates how much is taxable and how much is viewed as a return of your already taxed contributions, and lists the amounts on the form 1099-R that they mail you each January.
The amount of your pension that is taxable is based on the amount of your contributions and upon your age at the time you retire. Here’s an example for an employee receiving $35,000 per year in pension benefits who retired at the age of 57 and had contributed $50,000 towards his/her pension.
|Total pension received
|Total retirement contributions
|Life expectancy in months (based on IRS life expectancy table in Publication 721)
|Tax free amount per month (divide contributions by life expectancy in months)
|Tax free amount per year (monthly figure x 12)
|Taxable portion of pension (total pension minus annual tax free amount)
How is federal income tax withheld from your pension? Any way you want it to be. You will receive a form W4-P with your retirement papers and you can fill it out as you wish.
Until 1983, Social Security benefits were not taxed. From 1983 to 1993, up to 50% of Social Security benefits could be taxed. From 1993 to the present, up to 85% of Social Security benefits can be taxed.
The amount of your Social Security that can be taxed is based on your “provisional income.” To determine your provisional income, you add together one-half of your Social Security, all of your taxable income and certain non-taxable income (e.g., tax-exempt income etc.). Your provisional income is compared with thresholds established for single and joint filers. These thresholds have never been indexed for inflation since they were established in 1983.
Single filing status thresholds:
- If the total of the above items is less than $25,000, there will be no tax on SS benefits;
- If the total is between $25,000 and $34,000, up to 50% of SS will be taxable;
- If the total is over $34,000, up to 85% of SS will be taxable.
Joint filing status thresholds:
- If the total of the above items is less than $32,000, there will be no tax on SS benefits;
- If the total is between $32,000 and $44,000, up to 50% of SS will be taxable;
- If the total is over $44,000, up to 85% of SS will be taxable.
The amount of Social Security that is taxed is either 50%/85% of your benefits, or 50%/85% of the amount by which your income exceeds the “trigger points” listed above. Here’s an example:
You and your spouse file a joint return and your income consists of $30,000 of taxable income and $4,000 of tax free interest income. Your Social Security benefits were $5,000. Adding ½ of the Social Security benefits to the other income gives you a “provisional income” of $36,500 for the purpose of determining taxability of your Social Security. The $36,500 exceeds the trigger point for 50% of your Social Security being taxable. The amount that will be taxed is the lower of 50% of your Social Security ($2,500), or 50% of the amount that your provisional income exceeds the threshold ($2,250).
How are federal income taxes withheld from your Social Security? They are not, unless you request them to be. It is wise to fill out the form W-4V when you apply for Social Security. It sure beats having a nasty surprise at tax time.
I tell participants in the pre-retirement seminars that I conduct for my firm, Federal Career Experts, that most federal employees can count on having 85% of their Social Security benefits subject to federal income tax (at their rate for ordinary income). Agency Human Resources or Training staff can contact Federal Career Experts to find out more about our seminars.
Thrift Savings Plan
Withdrawals from a traditional TSP balance are fully taxable.
You already paid tax on your contributions to your Roth TSP balance. Further, there is no tax on withdrawals from a Roth TSP balance if your withdrawals are “qualified.” In order for a withdrawal to be considered qualified, you must be at least 59 ½ at the time of the withdrawal and you must have had a Roth balance in your TSP for at least five years. This means that a withdrawal from your Roth balance will not be considered qualified until at least 01/01/2017, and then only if you are over the age of 59 ½.
You are not allowed to separate withdrawals between your traditional and Roth TSP balances; all withdrawals must be proportional. If you have a Roth balance in your TSP, you should take care in making withdrawals, at least until your withdrawals will be qualified. Link to my article from a couple of years ago on roth taxation.
As the TSP is a tax deferred employer retirement plan, there are penalties for taking money out too early, or too late.
The 10% early withdrawal penalty will not apply to withdrawals from your Traditional TSP if you retire from your federal job in the year in which you turn 55, or later. It will also not apply to withdrawals taken by disability retirees. Individuals who retire from their federal job before the year in which they turn 55 can avoid the penalty if:
- They elect monthly payments based on the IRS life expectancy table and continue those payments for five years, or until they turn age 59 ½ whichever is longer; or
- They purchase a TSP annuity.
Though most defined contribution plans like the TSP have a 50% penalty for failing to take required minimum distributions beginning at the age of 70 ½, the TSP has provisions in place that shield almost all participants from the penalty. The penalty is 50% of the amount of money you should have taken out, but didn’t.
- If you are still working at your federal job at 70 ½, you are not required to take a minimum distribution.
- If you are taking substantially equal monthly payments at 70 ½ (the most popular withdrawal choice of those who do not roll their TSP account into an IRA or other instrument) and fail to take out enough to meet the minimum required distribution, the TSP will send you an additional payment of the required amount before the end of the year.
- If you are not working and haven’t begun withdrawals by 70 ½:
- The TSP will notify you at the beginning of the year after the year in which you turned 70 1/2 that you must begin taking out your money by April 1;
- If you do not begin withdrawing the money by April 1, the TSP will transfer all your money into the G fund;
- If you do not begin withdrawing your money within nine months, the TSP freezes your account.
Be aware that, because of the requirement for proportional withdrawals, you will have to begin taking money out of your Roth TSP at the same time you take required minimum distributions from your traditional TSP.
How are taxes withheld from your TSP? It depends on your withdrawal choice. A tax notice is updated annually and can be found in the “forms and publications” section of the TSP’s website. The notice has a detailed table that describes how each type of withdrawal is treated for tax purposes (e.g., periodic payment, eligible rollover distribution, etc.) and what the default withholding rate is.
State taxes of federal retirement, Social Security and the TSP
Most states have income taxes. Some states with income taxes do not tax any retirement income. Some states with income taxes give retirement income preferential treatment.
Every year the National Active and Retired Federal Employees Association (NARFE) prepares a detailed list of how the various states tax federal retirement benefits. NARFE members can access that list on the NARFE website, or see in in one of the Spring issues of the NARFE magazine. Kiplinger provided a “Retiree Tax Map” that covers all taxes that are of interest to retirees.