One of the greatest enemies of federal retirement is tax. Taxes can steadily chip away at a retirement nest egg. If retirees are unwise in their withdrawals from taxable accounts, they can seriously whittle away a once promising retirement. Federal retirees must be aware of which benefits are taxable and what that tax burden will be. However, taxes are not invincible. Although they cannot be entirely avoided, the damages of taxes to a retirement nest egg can be limited.
Taxes on Pension Income
FERS retirees will likely have three main sources of income in retirement: a FERS pension, Social Security benefit, and withdrawals from a Thrift Savings Plan (TSP) account. Which of these benefits is taxable? Potentially all of them are.
The federal tax on a FERS pension is not a set amount but depends on what tax bracket one falls into in retirement. At the state level, the tax burden on a FERS pension varies on a state by state basis. Some tax exemption states—like Florida and Alaska—have no tax on pension income. Other states, like Georgia, offer exemptions on certain amounts of retirement income.
Taxes on Social Security
At the federal level, Social Security may or may not be taxed. As of 2019, singles with incomes between $25,000- $34,000, have up to 50% of their Social Security benefits subject to taxation. Singles with incomes of more than $34,000 will have up to 85% of their Social Security benefits taxed. Married (filing joint) couples with a combined income between $32,000- $44,000 could have up to 50% of their Social Security benefits taxed. Married (filing joint) couples with a combined income greater than $44,000 will potentially have 85% of their benefits taxed.
Please note: combined income for federal retirees includes: pension, traditional TSP/IRA withdrawals, interest, dividends, etc., in addition to one half of the Social Security benefit.
Again, at the state level, the tax burden on Social Security depends on the state one resides in. Some states offer tax exemptions on Social Security while others have no tax at all. Below is a list of tax exemption states that have no tax on pension income and no tax on Social Security benefits.
For tax information on TSP withdrawals, see our video: Tax and TSP Update.
The Whole Story
Is this the whole picture when it comes to retirement? If you’re packing your belongings to head to one of the tax exemption states listed above, don’t pick up the moving truck yet. Just because a state has tax breaks on pension income and Social Security benefits, doesn’t mean it’s the best place for you to live. Sales tax and cost-of-living are two major elements to consider. These are factors that vary between specific areas within a state. Although the average cost-of-living in a particular state may be lower than where you currently reside, that doesn’t necessarily mean the cost-of-living in the specific city you move to will be lower. Generally, the bigger the city, the higher the cost-of-living will be.
We’ve really just scraped the surface of taxes for federal retirees. Because the tax code is complex and ever changing, you should speak with a financial professional.
Please note that all tax information is from 2019 and is likely to change in the future.
