Retired Military Officers Get Surprised When Filing Their Taxes for the First Full Year of Retirement
I see them every year. They come into my office just a little bit bewildered about the fact that after 27 years of getting a refund when they file their taxes they now have to stroke a check to the IRS to the tune of $5,000 - $6,000. They used the same number of allowances on their W-4 that they've always used. What went wrong?
Multiple Sources of Income Cause Multiple Tax Issues
Our tax system is progressive. That means that as your taxable income goes up the tax rate you pay goes up. What is important to understand is that the rate goes up on the "next" dollar earned. This is called your marginal tax rate.
Let me explain. The first dollar you earn literally has a tax rate of 0%. The $122,000th dollar of taxable income has a tax rate of 22%. This is what causes the problem.
Since you are retired from the military, you have two or more entities (DFAS and your employer) who think the first dollar they pay you is the first dollar you've earned and they don't withhold any taxes from it. In reality, one of them should probably withhold taxes of at least 12% on that first dollar earned. The following chart shows what I mean. The line on the second pay chart shows that the first dollar paid by the civilian employer should be withheld at 12% and some at 22%.
How Do You Fix the Under-Withholding Problem?
The best thing to do is to complete a Form 1040-ES and make sure that your withholding is accurate. Then go into MyPay and have an additional dollar amount withheld from your retired pay to make sure any deficit is taken care of. Don't mess around with changing allowances. It is too inaccurate. And don't forget state income taxes as well, even though the problem isn't as pronounced with them.
If a 1040-ES isn't in your future, then at least take the time to accurately complete your Form W-4. And if that is too much, then make sure your withholding is around at least $1,500 per month (assuming income of around $150,000) from all sources combined.
I've found that a lot of military officers, both retired and active, are unaware that if you under-withhold your taxes, you can be subject to penalty (some waivers apply). That's giving free money to Uncle.
Transitioning to the Civilian Sector Isn't Easy
Transition challenges exist regardless of when you leave the military. They're different for a one-term servicemember than they are for a senior military officer with 20 plus years of service. But in both cases, it is better to face them with support. In the financial realm you'll want to work with someone who knows the unique challenges facing transitioning senior military officers and the benefits available to you.
If you found this article useful, you might enjoy the following blog posts:
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by C.L. Sheldon & Company, LLC ), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. C.L. Sheldon & Company, LLC does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to C.L. Sheldon & Company, LLC website or incorporated herein, and C.L. Sheldon & Company, LLC takes no responsibility therefore. All such information is provided solely for convenience, educational, and informational purposes only and all users thereof should be guided accordingly. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from C.L. Sheldon & Company, LLC . To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. C.L. Sheldon & Company, LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the C.L. Sheldon & Company, LLC ’s current written disclosure statement discussing our advisory services and fees is available for review upon request. DISCLAIMER OF TAX ADVICE: Any discussion contained herein cannot be considered to be tax advice. Actual tax advice would require a detailed and careful analysis of the facts and applicable law, which we expect would be time consuming and costly. We have not made and have not been asked to make that type of analysis in connection with any advice given in this blog post. As a result, we are required to advise you that any Federal tax advice rendered in this blog is not intended or written to be used and cannot be used for the purpose of avoiding penalties that may be imposed by the IRS. In the event you would like us to perform the type of analysis that is necessary for us to provide an opinion, that does not require the above disclaimer, as always, please feel free to contact us.