State Fiscal Problems Threaten Higher Taxes On Federal Pensions

Federal retirees depend on their federal civil service annuity for much of their retirement income, but states facing financial problems may be looking to public sector pensions as a source of new revenue.

Federal retirees depend on their federal civil service annuity for much of their retirement income, but states facing financial problems may be looking to public sector pensions as a source of new revenue.

A state-by-state income tax analysis issued by the National Active and Retired Federal Employees Association (NARFE) shows that currently nine states have no income tax and nine more exempt the total amount of civil service annuities from their state income tax, but this equation may be changing.

A number of states are struggling to balance their budgets, and three states in particular – Illinois, Kansas, and Pennsylvania – are facing severe financial problems. Currently, both Illinois and Kansas exempt public sector pensions from state income taxes.

“Nowhere are federal retirees being singled out for higher taxation, but in some states there are moves to increase taxes on all retirees, which will affect federal retirees as well as workers in their state retirement systems,” according to Richard Thissen, NARFE National President. “NARFE is working with coalitions in the states to protect the pension rights of all public sector employees.”

One recent success for NARFE is in Alabama, where the association worked with other groups to defeat a plan that would impose a new income tax on federal and state pensions.

“Federal retirees must receive the same tax treatment as other public sector retirees according to the Supreme Court,” explains Mr. Thissen. This includes parity with the way military pensions are treated by states, although some states have chosen to ignore this requirement. Iowa has already decided to exempt military retirement pay, while taxing civil service annuities, despite the Supreme Court’s ruling in Barker et al. v. Kansas.

Related to general fiscal shortfalls, states are facing unfunded liabilities in their public pension plans after years of failing to make contributions needed to keep the plans solvent. As a result, politicians calling to reform insolvent state retirement plans are erroneously including the solvent FERS plan in their sights.

The jump in reported state and local government pension gaps is related to revised standards issued by Governmental Accounting Standards Board (GASB) that are designed to “ improve the way state and local governments report their pension liabilities and expenses, resulting in a more faithful representation of the full impact of these obligations.”

While the federal government addressed this pension problem decades ago with creation of FERS, most of the public conflate state pension problems with the federal pension system. In fact, significant government and employee contributions have kept FERS in balance for future retirees.

It is important to remember that state income tax is only one form of taxation. Some states that lack a state income tax make up their revenue in a higher sales or property tax.

“Annuities are important, but NARFE is working with coalitions at the state level to reduce other taxes for retirees, like increasing the homestead exemption to reduce their property taxes,” said Mr. Thissen. “In states like Florida, which has no income tax but high property taxes, this can make a real difference to retirees living on fixed incomes.”

Finally, remember that a low tax state may also provide fewer services. Sometimes people moving from a high tax state to a lower tax state find they miss services that they had come to expect, such as more inclusive senior services. It is not unusual to find a transplant from a high tax state starting to agitate for more local government services after living a few years in a low tax state.

“NARFE is working hard with other groups in individual states to protect, and where possible, improve retirement benefits of federal retirees, employees and their families,” explained Mr. Thissen.

States With No Personal Income Tax States Exempting Total Amount of Civil Service Annuities
Alaska Alabama
Florida Hawaii
Nevada Illinois
New Hampshire Kansas
South Dakota Louisiana
Tennessee Massachusetts
Texas Mississippi
Washington New York
Wyoming Pennsylvania


About the Author

Michael Wald is a public affairs consultant and writer based in the Atlanta area. He specializes in topics related to government and labor issues. Prior to his retirement from the U.S. Department of Labor, he served as the agency’s Southeast Regional Director of Public Affairs and Southeast Regional Economist.