A Tax To-Do List

Dealing with some common tax issues facing new retirees.

There is some good information on these issues in . Medicare Part B premiums are means-tested: If you have a higher adjusted gross income, you pay a higher premium. Most people will pay a Part B premium of $104.90 per month in 2013. However, if your modified adjusted gross income as reported on your IRS tax return from two years ago is above a certain amount, you may pay more. Here’s . Not long ago, a client of mine took a $20,000 distribution that increased the taxation of his Social Security and Medicare benefits so much he vowed never to do it again without calling first. He somehow thought he could just take out $20,000 and have $20,000 to spend. Had he called, I would have suggested he take some or all of the amount from a savings account that would be nontaxable -- or even borrow the money. The easiest and safest way is to file an estimated tax form. The form is very simple. The amount to be paid can easily be calculated by multiplying the monthly annuity check by the state tax rate. For example, let’s say your monthly annuity is $2,000 and your state’s income tax rate is 5 percent. That’s $100 per month. You could pay $300 in four estimated tax payments, which are generally due April 15, June 15, Sept. 15 and Jan. 15 of the following year. Another way to pay the state tax is to have excess state withholdings either before retirement or once the annuity is finalized. The National Active and Retired Federal Employees Association publishes a list of all of the states that do not tax federal retirement benefits, usually in the March or April issue of its magazine. Also, Kiplinger provides an . While you work, you contribute to either the Civil Service Retirement System or the Federal Employees Retirement System in your biweekly salary payments. This payment is generally 7 percent for CSRS employees (7.5 percent for certain special groups) and 0.8 percent for FERS employees (1.3 percent for special groups). These contributions are withheld after tax, meaning that you’ve already paid taxes on this part of your future retirement benefit. Tax law allows you to divide the total contributions by your life expectancy (based on IRS tables). The result of this is the nontaxable portion of the annuity. See for information on the calculation, which OPM generally makes for you. States generally follow the federal calculation. In addition, some states offer other tax incentives. The best source for this information is the NARFE magazine mentioned above. The short answer is, take out as little as possible from your TSP. This is because a distribution from a traditional TSP (as opposed to the new Roth option) is generally fully taxable, and the TSP is required to withhold 20 percent for pre-payment of federal tax from a lump sum payment or when your monthly payments are expected to last 10 years or less. The TSP will not withhold any state income tax from your lump sum distribution.

Last week, I wrote about things new retirees need to be aware of  as they make the transition into this new phase of life. This week, I want to focus on tax issues, and for that I’ve called on my associate, Bob Leins, CPA, for help.

But before I get to some commonly asked tax questions, I wanted to address some comments from last week’s column. Several of you said you had retired on Dec. 31, 2012, or Jan. 3, 2013, and had yet to receive any retirement benefit. Keep in mind that if your retirement began in January, your first retirement check would be dated Feb. 1, and you might not receive that check until mid-February at the earliest -- and it will be an interim payment. In the meantime, you should receive your final paycheck from your agency as well as the lump sum payment for accumulated and accrued annual leave.

By the way, the Office of Personnel Management received 22,187 new retirement claims in January. The backlog of applications now stands at 36,062 pending cases. So be prepared to be in interim status for at least a few months -- maybe more.

Now for Bob Leins’ response to the tax questions…

What is the biggest misunderstanding that employees have regarding taxes and retirement planning?

My pet issue is that retirees, as well as others, don’t fully understand tax brackets. Not that they should be tax accountants, but people have a hard time understanding that if a dollar is withdrawn from a taxable investment like the Thrift Savings Plan or fully taxable traditional Individual Retirement Account, the amount will be taxed at their highest tax bracket, both on the federal and state level.

For example, suppose an individual takes a $1,000 fully taxable distribution at a federal income tax rate of 15 percent and a state rate of 5 percent. If they need the full $1,000, they’ll  have to withdraw $1,250. If they’re in a higher federal bracket, say 25 percent, they’d have to withdraw $1,428.50 to net the $1,000.

What about Social Security taxes and Medicare premiums?

Social Security benefits are tax-free for some people, but for others, part of the benefit is taxable. The taxable part of benefits usually can’t be more than 50 percent. However, up to 85 percent of benefits can be taxable if either of the following situations applies to you:

  • The total of half of your benefits and all your other income is more than $34,000 ($44,000 if you are married filing jointly).
  • You are married filing separately and lived with your spouse at any time during 2012.

IRS Publication 554: Tax Guide for Seniors

more information on Medicare costs

During the interim retirement period, OPM does not withhold state income tax from my retirement benefit. What should I do if I live in a state that taxes federal retirement benefits?

How can I find out which states don’t tax federal retirement benefits?

interactive map

I’ve heard that part of my retirement is tax-free. Is that true?

IRS Publication 721

Does this apply to both the federal and state tax returns?

I might need to take some money from my TSP account after I retire if my first retirement checks are too small to cover my expenses. Any tax strategies that I can use here?