{"id":12290,"date":"2025-03-24T13:53:48","date_gmt":"2025-03-24T13:53:48","guid":{"rendered":"https:\/\/finderica.com\/?p=12290"},"modified":"2025-03-24T13:53:48","modified_gmt":"2025-03-24T13:53:48","slug":"4-myths-about-taxes-in-retirement","status":"publish","type":"post","link":"https:\/\/finderica.com\/?p=12290","title":{"rendered":"4 Myths About Taxes in Retirement"},"content":{"rendered":"
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When you\u2019re planning for retirement, you want to make certain that your money lasts as long as possible (preferably as long as you do!). What\u2019s one of the things that can derail an otherwise great retirement plan?\u00a0Taxes<\/em>.<\/strong><\/em><\/p>\n

Taxes can potentially wreak havoc on your retirement since you have to pay for them somehow\u2014and if you\u2019re not accounting for them, you may be forced to use your hard-earned savings. I refer to taxes in retirement as the \u201ccarbon monoxide\u201d that can kill an otherwise really good financial plan. It can sneak up on you quickly and without a lot of warning.<\/p>\n

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Many federal employees are confused when it comes to how their taxes will change in retirement. Here are a few common myths that you should know and avoid.<\/p>\n

Myth #1: You\u2019ll be in a lower tax bracket.<\/h2>\n

First, most federal employees believe that they will be in a lower tax bracket in retirement than they are right now. In reality, what actually happens is most people end up in the exact same tax bracket that they are in right before they retire from federal service.<\/p>\n

But how could this happen?\u00a0 Didn\u2019t you just take a big pay cut to retire?<\/em><\/h4>\n

It\u2019s easy to see why this confusion can occur. In retirement, instead of pulling your full salary, you\u2019re going to be pulling in a pension that is typically much less than the salary you have today. However, the idea of being in a lower tax bracket assumes that you\u2019re not pulling money from any\u00a0other<\/em>\u00a0places.\u00a0 Plus, as a federal retiree, you\u2019ll now be taxed on the money you use to pay your FEHB premiums (something you didn\u2019t have to do while you were working!).<\/p>\n

Imagine a scenario where you\u2019re at a certain level of salary and you take an obvious pay cut to receive your pension in retirement.\u00a0 However, because you still want the same standard of living in retirement, you need to fill in the income gap.<\/p>\n

If you do so with money from accounts like the Thrift Savings Plan (TSP) and Social Security \u2014 the vast majority of which are taxable \u2013 you will be right back in the same tax bracket as you were before retirement.<\/p>\n

Remember, there are only two reasons people end up in a significantly lower tax bracket when they retire:<\/p>\n

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(1) because they have significantly less money to live on in retirement (but who wants\u00a0that<\/em>?!), or<\/p>\n

(2) because they PLANNED to be in a lower tax bracket by implementing smart tax strategies when they were younger.<\/p>\n

Myth #2: You should move to a tax-friendly state when you retire.<\/h2>\n

When it comes to state taxes, there are some retiree-friendly states. In fact, there are eight states that don\u2019t tax anyone\u2019s income (including pensions).\u00a0 Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming have no income tax for any of their residents. A ninth state, New Hampshire, only taxes capital gains and dividend income.\u00a0Federal employees living in these states have absolutely no income tax, so their pension is not going to be taxed either.<\/p>\n

Sounds great, right? But before you start packing up your things and getting ready to move, you need to know that\u2019s only half of the story. Although these states don\u2019t have any state\u00a0income<\/em>\u00a0tax, the reality is that in states that have no income tax, they typically have higher sales tax and property tax.<\/p>\n

The states must get their revenue somehow and this is the way that they\u2019re going to do it. While on the surface, it sounds great to not have to pay state income tax, there are some consequences with respect to the other kinds of tax that you might experience.\u00a0 Read up carefully before you pack the moving truck!<\/p>\n

There are also six other states that do have income tax but have specifically excluded the taxation of the entire CSRS and FERS pensions. No matter how high it is, these six states will not tax your pension: Alabama, Hawaii, Illinois, Iowa, Mississippi, and Pennsylvania.<\/p>\n

In addition to these six states, there are five states that give an exemption to a certain amount of the pension and each one of these are different: Kentucky, Michigan, North Carolina, Oklahoma and Oregon. These 11 states tend to have moderate property tax and sales tax because they\u2019re getting the bulk of the state\u2019s revenue through income tax, just not from federal retirees.<\/p>\n

Again, I\u2019m not suggesting that you move to one of these special states in retirement. There are so many factors that go into choosing a state where it\u2019s most advantageous to live.\u00a0 Hopefully, the acknowledgement of these various states helps you to have these conversations about the tax considerations and where you\u2019re likely to be retired.<\/p>\n

Myth #3: My Social Security benefits won\u2019t be taxed.<\/h2>\n

Unfortunately, it\u2019s not just your retirement account withdrawals that are taxed \u2013 some of your benefits may be taxed as well. To really understand how\u00a0Social Security benefits are taxed<\/a>, you must look at both the federal and the state levels. At the federal level, roughly 85% of your Social Security benefit is taxable.<\/p>\n

Given the level of income that most federal retirees will have with their pensions, you can pretty much bank on 85% of your Social Security benefit being taxed. Out in the private sector, there are ways to get out of being taxed on Social Security. It takes a lot of prior tax planning, but given that federal retirees have a taxable pension, you won\u2019t be able to avoid being taxed on Social Security benefits at the federal level.<\/p>\n

As of 2025, there are only nine states that tax Social Security benefits: Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont, and West Virginia.<\/p>\n

Again, this is not a reason to move to or move out of a given state. It\u2019s just simply something that you need to consider in your retirement planning so that there are no tax surprises when you begin drawing your Social Security.<\/p>\n

Myth #4: I only have to pay taxes on the money I put in the TSP.<\/h2>\n

Most employees know that there are taxes due on the back end of their traditional Thrift Savings Plan (TSP<\/a>).\u00a0 Of course this happens because no tax was paid on the money that was put into the TSP (called \u201ctax deferred\u201d). However, what many federal employees don\u2019t understand is that they don\u2019t just owe tax on the\u00a0principal<\/em>, they also owe tax on all of the\u00a0growth<\/em>.<\/p>\n

For example, let\u2019s say you contribute $100,000 into the traditional TSP (over a long period of time), and that $100,00 grows to $200,000.\u00a0 Then the principal that you originally contributed ($100,000) was not taxed at the time and the growth ($100,000) has not been taxed yet \u2013 but don\u2019t worry, the IRS won\u2019t forget!<\/p>\n

Therefore, if you were to withdraw this $200,000 (either all at once or over a long period of time), you owe the tax on the entire $200,000 \u2014 not\u00a0just<\/em>\u00a0the money you put in, but all the growth, too!<\/p>\n

Don\u2019t let taxes surprise you in retirement.<\/strong><\/h4>\n

My best advice with respect to taxes is to recognize that they\u2019re very real in retirement. Take the time to work with your tax professional or financial planner and put a tax strategy in place. A little tax planning will help protect your retirement savings in the long run.<\/p>\n

\u00a0<\/p>\n

\u00a0<\/p>\n

<\/span><\/p>\n

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About Chris Kowalik<\/h4>\n

\"\"<\/u><\/a>Chris Kowalik is a federal retirement expert and frequent speaker to federal employee groups nationwide. In her highly-acclaimed FedImpact Workshops<\/u><\/a>, the FedImpact Podcast<\/u><\/a>, and the FedImpact Webinars<\/u><\/a>, she empowers employees to make confident decisions as they plan for the days when they no longer have to work. Chris\u2019 candid and straightforward nature allows employees to get the answers they need and understand the impact these decisions have on their retirement.<\/h5>\n<\/div>\n
DISCLAIMER: The information presented on MyFederalRetirement.com is provided for general information purposes. The information has been obtained from sources considered to be reliable. The information is offered with the understanding that the publisher is not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For more information, please read our Terms of Service.<\/span><\/h5>\n<\/div>\n
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