Understanding Taxation on Federal Retirement Benefits: FERS Annuity and Withholding Insights

Federal employees, like all wage earners, can face a complex landscape of tax considerations throughout their careers and into retirement. Understanding these implications is critical for effective financial planning.

Tax Considerations for Federal Employees During Active Service

As a federal employee, your income is subject to various federal taxes, and certain benefits you receive also have tax implications.

Learn about taxes, TSP, Social Security, and more at an online federal retirement seminar.

Federal Income Tax Withholding for Government Employees

Wages and Salary: Your regular salary and wages are subject to federal income tax withholding, just like any other employee. The amount withheld is determined by the information you provide on your Form W-4, Employee’s Withholding Certificate. It’s essential to review and adjust your W-4 periodically, especially after life events (e.g., marriage, birth of a child, changes in other income), to ensure accurate withholding and avoid underpayment or overpayment penalties.

Fringe Benefits: Many fringe benefits are taxable. This can include items like cash awards, gift certificates, and certain non-cash awards, which are generally treated as supplemental wages. Agencies are responsible for reporting these as compensation on your W-2 and withholding applicable taxes.

Social Security and Medicare Taxes (FICA)

Unless you are a traditional CSRS (Civil Service Retirement System) employee, Social Security and Medicare (FICA) taxes are generally withheld from your wages. These taxes fund Social Security and Medicare benefits. CSRS generally do not pay Social Security retirement, survivor, and disability (OASDI) tax, but they do pay the Medicare tax.

Social Security wage base limit: once your earnings reach a certain annual threshold ($176,100 in 2025), no further Social Security tax is withheld for that year. Medicare does not have a wage base limit; it’s withheld on all earned income.

Additional Medicare Tax: If your wages and compensation exceed $200,000 in a calendar year, your employer is required to withhold an additional 0.9% Medicare tax. There is no employer match for this additional tax

Thrift Savings Plan (TSP) Contributions

The Thrift Savings Plan (TSP) offers significant tax advantages while employed, whether you are contributing to a Traditional TSP or Roth TSP account. Many federal employees choose a mix of both Traditional and Roth TSP contributions to diversify their tax strategy in retirement.

Agency automatic (1%) and matching contributions are always made to your Traditional TSP balance and are tax-deferred. Qualified withdrawals from a Roth TSP in retirement are entirely tax-free, including earnings. To be qualified, the withdrawal must occur at least five years after January 1 of the year you made your first Roth contribution AND you must be at least age 59½, permanently disabled, or deceased. After five years, contributions (but not earnings) can be withdrawn without penalty regardless of age.

Estimate your retirement income with our TSP Calculator Tool.

Tax Considerations After Retiring from Federal Government

Retirement brings a new set of tax considerations, primarily centered around your pension, Social Security, and TSP withdrawals. Managing income sources in retirement is vital for federal annuitants. Having a financial planner you trust can be the difference between a comfortable retirement and a prosperous one.

CSRS or FERS Annuity is Taxed for Federal Retirees

The taxable portion of a FERS pension is determined by the retirement contributions made by the federal employee during their service. These contributions are made with after-tax dollars, meaning they are not subject to federal income tax again. However, the portion of the annuity that exceeds the employee’s contributions is considered taxable income. The Office of Personnel Management (OPM) will provide you with a Form 1099-R each January, which indicates the amount you owe when you pay taxes. If you receive the FERS Special Retirement Supplement (paid to certain FERS retirees before they are eligible for Social Security), it is 100% taxable as ordinary income. It’s also subject to an earnings test, meaning it can be reduced or eliminated if you earn above a certain threshold from other employment before age 62. CSRS and FERS annuities are similar when it comes to income tax purposes.

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You can choose to have federal income tax withheld from your monthly annuity payments by completing Form W-4P and submitting it to OPM’s retirement services. If you don’t specify withholding, OPM may default to a certain rate (e.g., married with three allowances), which might not be appropriate for your tax situation. It is absolutely crucial to review your withholding annually.

Federal Retirement Tax Return: Thrift Savings Plan (TSP) Withdrawals

Distributions from your Traditional TSP are fully taxable as ordinary income when you withdraw them. Qualified withdrawals from your Roth TSP are entirely tax-free. Read this article to learn how to rollover TSP money into an IRA. Once you reach a certain age (currently 73 for most, potentially 75 for those born after 1959), you must begin taking RMDs from your Traditional TSP account (and other tax-deferred accounts). These withdrawals are taxable. Failing to take RMDs can result in significant penalties. Roth TSP balances are not subject to RMDs during the original owner’s lifetime. Inheriting Roth TSP funds can have tax consequences. The TSP typically withholds federal taxes from withdrawals. The default withholding rate can vary depending on the type of withdrawal (e.g., lump sum vs. installment payments). You can adjust your withholding by submitting Form TSP-78 or making selections during the withdrawal process.

Social Security Benefits Taxation and Federal Tax Withholding

A portion of your Social Security benefits may be subject to federal income tax, depending on your “combined income.” Combined income is generally your adjusted gross income plus any tax-exempt interest income and one-half of your Social Security benefits. Social Security does not automatically withhold federal income tax from your benefits unless you specifically request it. You can do this by submitting Form W-4V to the Social Security Administration or by making quarterly estimated tax payments.

Gross Income for Federal and State Income Taxes Impact on Retired Federal Employee

Federal and state taxation differ in terms of rates, exemptions, and the types of income that are taxed. Federal income tax is imposed on a national level and applies to all taxable income, including FERS annuities and Social Security benefits. State income tax, on the other hand, varies by state and may include different exemptions or deductions for retirement income. Some states do not tax retirement income at all, while others may tax it at a reduced rate. Federal retirees should meet with a tax advisor to effectively plan their tax strategy. Meet with a financial planner for federal retirement to attain your retirement goals. 

Some States Tax Sources of Income in Retirement

State income tax can significantly affect the net retirement income of federal retirees. Depending on the state of residence, retirees may be subject to additional taxes on their FERS annuity and Social Security benefits. States like Florida and Texas do not impose state income tax, providing a tax advantage for retirees. However, states like California and New York have higher tax rates, which can increase the overall tax burden. Retirees should consider the state tax implications when choosing a retirement location and consult with a tax professional to optimize their tax situation. Receiving Social Security benefits can impact the taxation of federal retirement benefits. The combined income calculation used to determine the taxable portion of Social Security benefits includes FERS annuity payments. As a result, higher annuity payments can increase the taxable amount of Social Security benefits. 

Individual Retirement Plan for Federal Income Tax Purposes

Once retired from federal service, reducing taxable income is a key strategy for managing taxes on federal retirement income. Retirees can take advantage of tax deductions, credits, and exemptions to lower their taxable income. Contributing to qualified retirement accounts, such as IRAs or 401(k)s, can also reduce taxable income. Additionally, retirees can explore tax-efficient withdrawal strategies and consider the timing of income recognition to optimize their tax situation. Ordinary income tax rates fluctuate over time.

Use the IRS Tax Tables and Tax Withholding Estimator on Government Website

Tax tables are valuable tools for planning and estimating tax liability. Retirees can use these tables to determine their marginal tax rate and calculate the impact of different income levels on their tax bill. By understanding how their retirement income is taxed, retirees can make informed decisions about withdrawals, withholding, and estimated tax payments.