How is your retirement income, specifically your FERS annuity, Social Security, and TSP withdrawals, taxed for federal income tax purposes? The taxable portion of each of these sources of income are taxed as ordinary income; that is, they receive no special tax treatment are taxed based on the bracket in which they fall.
The vast majority of your FERS annuity will be federally taxable. You will not be taxed on the portion of your FERS annuity that is due to your already taxed contributions but, because you recoup your contributions bit by bit over your life expectancy, most of your FERS annuity is taxed. The form 1099-R you receive from OPM will tell you how much is taxable.
It is quite likely that 85% of your Social Security will be subject to federal income tax at your rate for ordinary income, though some retirees will find that a lesser portion is considered taxable; the higher your income the higher the percentage of your Social Security benefit that is subject to federal income tax. You will determine how much of your Social Security is taxable when you are filling out your tax forms.
Distributions from your traditional TSP are fully taxable for federal income tax purposes. Distributions from your Roth TSP will be tax free if the withdrawals are qualified. For a Roth withdrawal to be considered qualified, you must have had the Roth account for at least 5 years and be at least 59 ½ years old. If your Roth withdrawals are not qualified, you will pay taxes on the portion of your Roth distribution that is due to earnings; withdrawn contributions are never taxable, because your contributions were made out of already taxed dollars. In the Roth TSP (unlike a Roth IRA) Roth withdrawals come proportionally from contributions and earnings.
The above paragraphs tell how your retirement income is taxed – not how taxes are withheld from said income. We’ll look at withholding in the paragraphs below.
Regarding your FERS annuity, you likely filled out a W-4P with your retirement papers and now taxes are being withheld from your monthly payments. You probably based this withholding on the last W-4 you filed while still an employee and it will most likely cover all taxes due from your annuity.
On the other hand, Social Security will not withhold one red cent from your benefits for taxes unless you ask them to! In order to be sure enough is withheld for taxes, you can:
Ask Social Security to withhold from your monthly payments. You can do this when you apply (if you’re applying online, you do it in the “remarks” section of the form) or you can file a form W-4V after you have applied.
Make quarterly estimated tax payments. These payments which are due on April 15, June 15, September 15 and January 15 (or a few days later depending on the day of the week the 15th falls on) require you to remember to set aside the money for the payment and remember to actually send it in. I don’t trust my memory (or my ability to keep my hands off money that I have set aside) so, when I filed for Social Security, I requested that they withhold a percentage of my benefit for federal income taxes. If I don’t see it, I won’t miss it.
The Thrift Savings Plan withholds taxes at different rates for different types of payments. They have a booklet available on their website, tspbk26.pdf that contains a detailed table describing the withholding on each different type of withdrawal. According to TSP statistics, the most common withdrawal is installment payments and with that type of withdrawal (if the payments are likely to continue for 10 years or more) taxes are withheld as if you were married, filing jointly, and claiming 3 exemptions. This will almost certainly result in not enough taxes being withheld and might even cause a tax penalty. Just because you’re not having taxes withheld doesn’t mean that you don’t owe taxes.
Most other types of payment from the TSP withhold at a 20% rate, which may (or may not) be sufficient to cover your federal income taxes.
Those of you who live in states that tax retirement income and/or Social Security should be aware that neither Social Security nor the TSP withhold state income taxes. You will want to either make estimated payments to your state taxing authority or have more withheld from other sources of income.
If you’re just retired, or planning on retiring in 2023, plan on having enough money withheld this year to cover your taxes and avoid any penalties. Remember, tax avoidance is OK – it’s tax evasion that’ll get you into trouble.
Finally, to get the best idea of where you stand going into retirement, we do suggest you get a Full Retirement Consultation with a Federal Retirement Consultant. Please visit the contact us page to start the process to schedule your Free Retirement Review.