Retired Military Finances 101: TaxesRetirement Funding Taxes Military Pay and Benefits
You just recently retired from the military or you're just about to, and you realize you haven't really thought that much about how your tax picture will change. Just what will be taxed and what won't be taxed? Here are the basics...
Military Retirement Pay
At the Federal Level, all of your military retirement pay is taxed as ordinary income. That means you'll pay the same income tax on your retirement pay as if you earned it as wages. At the State Level, it depends. Here is a quick summary...
- Only 8 states tax all your military retirement pay
- 13 states tax a portion of your military retirement pay
- 20 states don't tax any retirement pay, and
- 9 states don't tax any income, so they won't tax your military retirement pay either
Your military retirement pay is not considered "earned income" from a tax standpoint (I didn't say you didn't earn it, you earned every penny). This means your military pension is not subject to Social Security or Medicare tax.
Veterans Disability Compensation
In general, VA benefits are not subject to income taxes. This includes VA Disability Compensation along with GI Bill benefits. So you won't have to worry about paying taxes at the Federal or State level on your VA Disability Compensation. But, it isn't quite that simple. If you are rated less than 50% disabled, then for each dollar of VA Disability Compensation you receive your military retirement pay is reduced by one dollar. In essence you turn taxable income into tax-free income. If this applies to you and your claim took a while you might want to read my article here. If you are rated more than 50% disabled, then as a practical manner, your military retirement pay remains fully taxable and you receive your VA Disability Compensation on top of it (still tax free). This is not the case if you receive Combat Related Special Compensation (CRSC). To find out more about CRSC, read the article here.
Social Security Benefits
It may be a while before you actually receive Social Security benefits, but you should know how they will be taxed as well. Currently, Social Security benefits can be tax free, 50% of the benefits can be subject to income tax, or 85% of the benefits can be taxable. If you retired from the military as an officer, almost certainly 85% of your benefits will be subject to federal income tax. 37 States do not tax Social Security Benefits.
While not a tax per se, your Medicare premiums will most likely be deducted from your Social Security payment and the premiums are higher for those who have more income. The first break-point for increasing the premium is $170,000 for those Married Filing Jointly and $85,000 for all others. That may sound like a lot but with your military pension, Social Security and required minimum distributions from the Thrift Savings Plan (TSP) you could hit that pretty quickly.
Military Retirement Not the Same
Just like serving in the military isn't like any other "job", being retired from the military isn't like being a retired civilian. If you decide to work with a financial advisor, make sure you work with one who understands your benefits and tax picture.