Federal retirement tax guide

Here is a quick-reference summary of federal tax treatment for each FERS retirement income source:

The combined effect of these sources means most federal retirees face a meaningful effective tax rate in retirement — often 15–22% effective federal rate for married retirees with a modest pension, Social Security, and TSP withdrawals. Planning how to sequence and size withdrawals from each source is the primary lever for managing retirement tax liability.

Your FERS annuity is taxed as ordinary income at the federal level. OPM withholds federal income tax from each monthly payment based on a withholding election you provide (using the W-4P equivalent). You report the taxable portion on Schedule 1 of your federal return.

OPM issues Form 1099-R at the end of each tax year showing:

• Box 1: Gross distribution (total annuity paid)
• Box 2a: Taxable amount (gross minus the tax-free exclusion)
• Box 4: Federal income tax withheld
• Box 7: Distribution code (usually "7" for normal retirement)

Most FERS retirees find that nearly the entire annuity is taxable, because the after-tax contribution amount they excluded is small. See the Exclusion Ratio section below.

No 10% early withdrawal penalty: The 10% early withdrawal penalty that applies to 401(k) and IRA distributions before age 59½ does not apply to FERS pension payments. Your annuity is penalty-free at any retirement age.

FERS is not Social Security: Although OPM withholds federal income tax, they do not withhold FICA (Social Security and Medicare payroll taxes) from your annuity payments. Your annuity is not "earned income" for Social Security contribution or credit purposes.

Because FERS employees contributed to their retirement on an after-tax basis (the employee contribution of 0.8%, 3.1%, or 4.4% of salary was taken from net pay, not pre-tax), a portion of each annuity payment represents a tax-free return of those contributions.

The IRS's Simplified General Rule determines how much of each payment is excludable:

1. Determine your total after-tax employee contributions (shown on your OPM retirement packet)
2. Divide by the number of expected payments based on your age at retirement (from the IRS table in Publication 575)
3. The result is the tax-free amount per monthly payment

Example: You contributed $30,000 after-tax to FERS over your career. You retired at 62. The IRS table assigns 310 expected payments for age 62. Your monthly exclusion is $30,000 ÷ 310 = $96.77/month. On a $3,000/month annuity, only $96.77 is tax-free — a 3.2% exclusion. The remaining $2,903.23 is fully taxable.

Once you have received enough payments to fully recover your after-tax contributions, the entire annuity becomes taxable with no further exclusion.

OPM calculates this exclusion for you and reflects it in Box 2a of your 1099-R. You generally do not need to calculate it yourself — but understanding why the taxable amount is what it is helps avoid confusion.

Traditional TSP: Every dollar you withdraw from your traditional TSP balance is taxable as ordinary income in the year you receive it — both your contributions and all investment growth. There is no partial exclusion as there is with the FERS pension, because traditional TSP contributions were made on a pre-tax basis. The TSP withholds 20% federal income tax on eligible rollover distributions (lump sums and installments) unless you elect otherwise.

Roth TSP: Qualified Roth TSP distributions are entirely tax-free. A distribution is "qualified" if:

• The Roth TSP account has been open for at least 5 tax years (counted from January 1 of the first year you made a Roth contribution), and
• You are age 59½ or older (or disabled, or the payment is made to a beneficiary after your death)

If either condition is not met, the earnings portion of a Roth distribution may be taxable. Contributions (your after-tax principal) are always distributable tax-free from Roth TSP.

RMDs: Traditional TSP balances are subject to Required Minimum Distributions beginning at age 73. RMDs are calculated based on your prior December 31 balance divided by the IRS life expectancy factor for your age. RMDs are taxable income. Roth TSP balances are not subject to RMDs during your lifetime under SECURE 2.0.

10% penalty exception: The 10% early withdrawal penalty applies to TSP distributions before age 59½, with certain exceptions. Distributions after separation from service in the calendar year you turn 55 or older are penalty-free (the "Rule of 55"). Federal employees who retire at their MRA in their late 50s may benefit from this rule for TSP withdrawals.

Social Security benefits are partially taxable at the federal level for many retirees. The portion that is taxable depends on your "combined income" — a concept specific to Social Security taxation:

Combined income = Adjusted Gross Income + Nontaxable interest + ½ of Social Security benefits

For most FERS retirees — who have a FERS pension, TSP withdrawals, and Social Security — combined income almost always exceeds the $34,000/$44,000 thresholds. This means 85% of your Social Security benefit is typically taxable for federal retirees.

These thresholds are not indexed for inflation (they have not changed since 1993), so an increasing proportion of Social Security recipients fall into the 85% taxable range each year.

State Social Security taxation: Most states do not tax Social Security. States that do partially tax SS benefits include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, and Vermont. Each has different income thresholds and exemption rules.

The FERS Annuity Supplement (the bridge payment that approximates Social Security from MRA+30 retirement until age 62) is taxable as ordinary income. It is reported on your 1099-R alongside your regular FERS annuity.

Importantly, the supplement is not treated as Social Security for tax purposes. Real Social Security benefits receive the partial exclusion calculation described above (0–85% taxable based on combined income). The FERS supplement has no such exclusion — the entire amount is taxable as ordinary income, similar to wages or pension income.

For a retiree receiving an $18,000/year supplement, the full $18,000 is added to adjusted gross income, potentially pushing them into a higher tax bracket or increasing the taxable portion of actual Social Security later.

This is a commonly missed tax planning point: in the years between retirement and 62, the supplement income is treated more harshly (fully taxable) than Social Security itself will be once the supplement stops and SS begins.

State income tax treatment of FERS pension income varies significantly by state. This is one area where your state of residence at retirement can make a meaningful difference in your net income.

States with no income tax: Florida, Texas, Nevada, Wyoming, Washington, Alaska, South Dakota, and Tennessee (investment income only). If you retire in one of these states, your FERS pension, TSP withdrawals, and Social Security are all state-income-tax-free.

States that specifically exempt federal civil service pensions: Alabama, Hawaii, Illinois, Kansas (partial), Louisiana, Massachusetts, Michigan, Mississippi, New York, and Pennsylvania, among others. Exemption rules vary — some states exempt all government pension income, some only exempt federal pension, some have income-based phase-outs.

States that tax federal pensions like private-sector pensions: California, Connecticut, Minnesota, New Jersey, Rhode Island, Vermont, and others. In these states, your FERS annuity is subject to state income tax at ordinary rates.

State tax rules change regularly through legislation. Always verify your state's current treatment with a tax professional or your state's department of revenue before retirement planning. The table above is a general guide, not legal advice.

For employees within a few years of retirement who have flexibility on location, the state tax differential can be worth thousands of dollars per year. Moving from California to Florida on a $50,000 annual pension could save $2,500–$4,000/year in state taxes alone.

Active FERS employees participate in FEHB Premium Conversion, which means their employee share of FEHB premiums is paid on a pre-tax basis — similar to Section 125 cafeteria plan deductions in the private sector. This reduces your taxable wages while you are working.

When you retire, FEHB premiums are deducted from your annuity on an after-tax basis. There is no equivalent pre-tax treatment for retirees. This means the same dollar amount of premium costs you more in effective dollars as a retiree than as an active employee, because you no longer receive the tax benefit.

Medical expense deduction: If your total out-of-pocket medical costs (including FEHB premiums) exceed 7.5% of your adjusted gross income, you may be able to deduct the excess on Schedule A as an itemized deduction. For most federal retirees with a pension and TSP income, this threshold is high and the deduction rarely applies — but it is worth tracking if your medical costs are substantial.

Medicare Part B premiums, which many federal retirees pay starting at 65, are also paid after tax — but they may be deductible as a medical expense under the same 7.5% threshold rule.

When your annuity begins, OPM automatically withholds federal income tax based on a default withholding election (typically "married, 0 exemptions"). You can change your withholding at any time through OPM's Services Online portal at servicesonline.opm.gov.

Why withholding matters: Unlike wages, your annuity does not include automatic state tax withholding unless you specifically request it (and your state participates). If your state taxes your pension, you may need to make quarterly estimated state tax payments to avoid underpayment penalties.

TSP distributions: The TSP withholds 20% federal income tax on eligible rollover distributions (one-time withdrawals and installment payments). For periodic installments that are not eligible rollover distributions (installments expected to last 10+ years), the default withholding is based on a "married filing jointly, 3 exemptions" equivalent. You can adjust TSP withholding on the TSP website.

Planning tip: In the first year of retirement, your income sources may change significantly month by month (interim annuity, lump-sum annual leave payout, TSP withdrawals starting). Review your withholding carefully in the fall of your first retirement year and make estimated tax payments if needed to avoid an April surprise.

Federal retirees with multiple income streams — pension, TSP, Social Security, part-time income — often find it simplest to increase withholding on one source (usually the OPM annuity) rather than making quarterly estimated payments. Both methods are valid, but withheld taxes are generally treated as if paid evenly throughout the year, which can help avoid underpayment penalties.