As you plan for retirement, your budget should be one of your primary concerns. After all, you have to calculate your expected cost of living, medical care, and other expenses to make sure you will be able to live comfortably once you retire.
But many people forget to factor the cost of taxes into their retirement budgets, and face a big surprise in the spring. Here’s what you need to know about taxation of your federal retirement benefits.
The first thing to know is whether you are retiring under the CSRS or FERS system. Either type of pension will be taxed according to usual federal income tax rates. Since your contributions were already taxed during your career, that part of your pension is returned to you free of taxation. However, the rest of it – the majority of your pension – will indeed be taxed.
If you invested in a Thrift Savings Plan, that part of your retirement income will also be taxed. Social Security income is taxed, depending upon your overall annual income and your tax filing status. In other words, pretty much all of your retirement income might subject to federal income taxes. As in any other tax situation, the exact amount will depend upon your personal exemptions, credits, dependents, and so on.
State income taxes, on the other hand, are the big variable in this equation. Ten states do not tax federal pensions at all: Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York, and Pennsylvania. Several states do tax federal pensions, but at different rates depending upon your years of service, your date of retirement, or the date on which you first began working for the federal government.
If you’re planning to move once you retire, the federal income taxes on your retirement income will be the same no matter where you choose to live. But before you move to a new state, consider carefully the impact of state income taxes. As always, consult with your financial professional about your plans for retirement, do your research, and review your expected budget carefully to prevent any unpleasant surprises.
