Tax time is getting closer and, 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. FERS pension contributions are higher for those who were hired January 1, 2013 or later.
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.
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). Recently the government has been contributing over 13% towards the retirement of FERS employees.
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 you don’t have to do the math because, in most cases, OPM calculates how much is taxable and how much is viewed as a return of your already taxed contributions, and lists those 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|| $35,000|
|Total retirement contributions||$50,000|
|Life expectancy in months (based on IRS life expectancy table in Publication 721)||360|
|Tax free amount per month (divide contributions by life expectancy in months)||$138.89|
|Tax free amount per year (monthly figure x 12)||$1,666.68|
|Taxable portion of pension (total pension minus annual tax free amount)||$33,333,32|
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 1987, Social Security benefits were not taxed. From 1987 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 “combined income.” To determine your combined income, you add together one-half of your Social Security, all of your other taxable income and certain non-taxable income (e.g., tax-exempt income etc.). Your combined income is compared with thresholds established for single and joint filers. These thresholds have never been indexed for inflation since they were established by the Tax Reform Act of 1986.
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.
Most federal retirees will find themselves paying federal income tax on 85% of their Social Security.
How are federal income taxes withheld from your Social Security? They are not, unless you request them to be. It is wise to either fill out form W-4V or note how much you want withheld in the remarks section of your application at the time you apply for Social Security. It sure beats having a nasty surprise at tax time.
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, if you started participating in the Roth TSP when it was introduced in 2012, your withdrawals from your Roth balance became qualified on 01/01/2017 – if you were over the age of 59 ½ at that time. If your withdrawals are not qualified, the portion of your Roth withdrawal that is deemed to come from earnings will be taxed.
Those who have both Roth and traditional balances in their TSP need to be careful if their Roth withdrawals will not be qualified. You are allowed to specify from which of your TSP balances you want your withdrawals to come. If your withdrawals will not be qualified, you want to be sure to specify that your entire withdrawal come from your traditional TSP balance. Absent such specification, your withdrawal will be taken proportionally and Roth earnings will be taxed.
Because 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 TSP if you separate from your federal job in the year in which you turn 55, or later (50 for special category employees).
There are other exemptions from the penalty that can be found in the TSP’s publication, Tax Information: Payments from Your TSP Account, which can be found on the TSP website. Individuals who separate from their federal job before the year in which they turn 55 (50 for special category employees) 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 installment 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 send you a required minimum distribution by the deadline each year.
Be aware that, unlike a Roth IRA, the Roth TSP requires minimum distributions.
How are taxes withheld from your TSP? It depends on your withdrawal choice.
The tax notice cited above is updated annually and 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. The withholding rate is not likely to be enough to cover taxes on most installment payments, so you may wish to have more taxes withheld; you can request additional withholding on your withdrawal form.
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.