As you prepare for retirement, it’s normal to focus on your potential retirement income, budgeting, and making plans for the hobbies or travel that you hope to pursue. But there’s one other very important consideration that many people planning for retirement forget to analyze: You might be surprised by changes to your income tax situation once you retire.
As a federal employee, you face several potential tax pitfalls in retirement. This is due to the fact that your income will be derived from three different sources once you retire: Your pension, Social Security, and any income from your Thrift Savings Plan distributions.
Social Security. Federal employees pay taxes on 85 percent of their Social Security benefits, but Social Security does not automatically withhold these taxes from your checks each month. This could trigger a surprise at tax time, possibly the 10 percent estimated tax penalty (ETP). You can head off this problem by filling out form W-4, and having federal income taxes withheld from your benefits.
Thrift Savings Plan. If you take a single payment from your TSP, the default tax withholding rate will be 20 percent. Whether or not this is adequate will depend on your overall income situation. Otherwise, you will receive monthly payments, and the TSP will not withhold taxes unless your monthly payment is at least $1,500 per month. You can request tax withholding so that you don’t face a surprise each spring at tax time. And of course, if you take Roth withdrawals, there will be no need to withhold taxes because this type of retirement income is not taxed anyway.
Many retirees face an unpleasant surprise after their first year of retirement. When they file their taxes in the following spring, they discover that failing to have enough taxes withheld to cover taxes can trigger a 10 percent penalty (in addition to the tax). Tax are unavoidable, of course, but the penalty is not. Remember, as you plan for retirement, to estimate your tax burden and adjust your withholding accordingly. If you need help calculating these figures, give us a call and we’ll be happy to help you plan your retirement expenses.Read More