Most of us look forward to retirement for similar reasons: No more alarm clock, no more cubicle, no more commute, and no more punching the clock. These things are true no matter where you work. Retirement is just a simpler way of life!
But no matter who you are, what you did for a living, or when you retired, one thing doesn’t change: You will still owe income taxes each year. Of course, your tax bracket might change, and to some extent the amount of your taxable income might change.
You won’t be paying payroll taxes anymore (Social Security and Medicare) but your income will be taxed as ordinary income in most cases. Your tax rate will depend upon your tax bracket, which might stay the same, or move up or down in retirement. However, some forms of retirement income are not taxable.
So how are federal employee benefits taxed? Throughout your career, you paid into your pension on an after-tax basis. So, the money you receive from your contributions in retirement won’t be taxed again. But you will pay taxes on the employer contribution part of those benefits, and on the earnings from contributions. The taxable part of your pension is based upon a formula that takes into account your retirement age and the amount of your contributions.
In other words, part of your federal employee benefits will be tax-free in retirement, while some will be subject to income taxes. You will need to plug your information into the formula in order to see how much of your benefits will be taxed.
You will also face a choice as to how these taxes are paid. Around the time you retire, you will receive a packet of papers pertaining to your benefits. Form W4-P offers you the option to have federal income taxes deducted from your pension, on a monthly basis. You can also elect to simply pay the taxes due each spring when you file your tax return.
Hopefully, this helped to explain how your pension benefits might be taxed in retirement. Next week, we’ll discuss taxes related to your Thrift Savings Plan.
Before you retire, schedule a meeting with us so that we can help you calculate the income taxes on your federal employee benefits. Then, together we can decide upon a strategy that best benefits you.