If you assume you’ll be in a lower tax bracket when you retire from federal service you’re really dropping the ball. Especially if the majority of your retirement savings is in your tax-deferred, traditional Thrift Savings Plan (TSP) account.
In fact, many federal retirees are shocked to find they’re actually in a higher tax bracket once they’re no longer working. Add to this, after the Trump tax cuts expire in 2025, everyone will likely land in a higher tax bracket.
Why Employer Contributions & Earnings Are Taxable
Let’s start with your FERS annuity (pension). Though you paid into your FERS pension with after-tax dollars, the majority of your monthly benefit is comprised of untaxed employer contributions and account earnings. As a result you’ll owe federal income taxes on as much as 90% or more of your total FERS pension payments each tax year.
When it comes to your traditional TSP, 100% of your contributions, plus your employer matches and your account earnings, are subject to federal income taxes. Even worse – depending on where you live, some or all of your pension payments and TSP distributions are subject to state income taxes. And don’t forget that 50% to 85% of your Social Security is taxable when your combined income exceeds thresholds established by the IRS.
As Ben Franklin famously said, “In this world nothing can be said to be certain, except death and taxes.”
Crunching The Numbers Based On The 80% Rule
Your tax burden in retirement depends on a number of factors. The basic rule of thumb is that you’ll need 80% of the income you currently earn to maintain your lifestyle once you retire. If you’re earning $100,000 annually, you’ll need a total income of at least $80,000 from your net FERS pension, TSP distributions and monthly Social Security combined.
As discussed above, a large portion of this federal retirement income is subject to income taxes. And don’t forget taxable income from a 401(k) or IRA your spouse may have. And, if the Trump tax cuts are not extended or made permanent in 2025, the standard deduction will be less than half as much as it is now. This is why it’s entirely possible that you may be bumped up into a higher tax bracket in retirement.
Tax-Planning Is An Essential Component Of Your Retirement Plan
As Ben Franklin famously said, “In this world nothing can be said to be certain, except death and taxes.” Without professional tax planning, you may end up with a bigger tax bill in retirement than you ever expected. To learn more, connect with an FRC® trained advisor who understands your federal benefits.
