It may seem logical to assume that dealing with taxes in retirement won’t be that complicated. Your income will be less than when you were working for Uncle Sam and, with the kids out on their own, you won’t have that many deductions. Then again – there are a number of misconceptions about taxes in retirement that may leave you with a larger-than-expected tax bill.
Misconception: I’ll Be In A Lower Tax Bracket
Some people end up in a lower tax bracket in retirement but you can’t assume you’ll be one of them. As much as 90% or more of your FERS annuity (pension) is taxable because it’s comprised of the government’s untaxed contributions and taxable earnings that accrue on both your contributions and the government’s contributions. Add in taxes on distributions from your traditional Thrift Savings Plan (TSP), plus withdrawals from 401(k) accounts you and your spouse may have from private sector jobs, and Uncle Sam will want his cut.
“Since these IRS thresholds have not been adjusted for inflation and remain rather low, more and more retirees find themselves owing taxes on their Social Security.”
Misconception: My Social Security Benefits Are Not Taxable
That was true when F.D.R. signed the Social Security Bill in 1935 but it all changed in 1984 during the Reagan Administration. Now, 50% to 85% of Social Security benefits are taxable when a retiree’s combined income exceeds the following thresholds established by the IRS.
If you file a federal tax return as an “individual” and your combined income is between:
- $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits.
- More than $34,000, up to 85% of your benefits may be taxable.
If you file a joint return, and you and your spouse have a combined income between:
- $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits.
- More than $44,000, up to 85% of your benefits may be taxable.
Since these IRS thresholds have not been adjusted for inflation and remain rather low, more and more retirees find themselves owing taxes on their Social Security.
Misconception: I Only Owe Taxes On My TSP Contributions
Though most federal workers know they’ll owe taxes on their traditional TSP distributions, a common misconception is that only their tax-deferred contributions are taxable. Not true. In addition to owing taxes on your contributions, matching contributions from your agency and investment earnings are 100% taxable.
Putting a tax plan in place before you retire helps to protect the benefits you’ve worked hard to earn. Consider working with an FRC® trained advisor who can connect you with a reliable tax professional who understands your federal benefits.
