Delivered on: Friday, July 28, 2023

Taxes in Retirement

Understand the tax implications of retiring and what steps to take today to be ready when it happens

  • TAX BRACKETS: How your tax bracket may or may not change when you retire
  • TAX TREATMENT: What federal benefits will be taxed and how
  • TAX CHANGES: When to expect significant changes to the taxability of federal benefits

Download Handouts: CLICK HERE

Register for our next 30-minute webinar:

Find a comprehensive retirement workshop for your area:

For an introduction to a financial professional in our network:


Prefer to read instead? Here’s a transcript of this webinar:

Welcome everybody to today’s FedImpact webinar on taxes in retirement. Gosh, we have a lot of different topics that we talk about on these sessions on our podcast and our articles, but taxes seem to be top of mind for federal employees, and so we wanted to do a little bit of a deeper dive today. We’re actually resurfacing a webinar that we did quite a while ago, several years ago, and we’ve of course updated some numbers and I was very careful to look back at the questions that we received on that webinar to make some modifications to today’s session so that you guys were getting the very most out of your experience today.

Now for today’s topic, we have quite a bit to cover. We’ll talk a little bit more about the topic itself, but definitely a wide variety of different types of employees on the call today. Y’all are going to be in different tax situations, and so you’re going to come at this from all sorts of different angles, and we’re going to do our very best to answer the questions that you have. We do have our support team standing by to answer questions.

Now, fair warning, we’re not here to give tax advice. We don’t know everybody’s situation, so we’ll do our very best to answer all of the questions that come in. Given the volume of those who are on today’s session live with us today, it may be a little bit difficult for us to get to everyone’s questions, but we will do our level best to do so. Now, handouts are available for download. You can either do that right in the webinar portal or if you look to the bottom of your screen, you’ll see a link to the handouts there as well.

Now, as always, this session is being recorded. We will give you the link to the replay following today’s session. Okay. Now stay till the end. Like I said, I have jam packed this thing with lots of actionable items for you and a lot to think about as you are thinking about what your own tax situation might look like in retirement.

Now, really quick, my name is Chris Kowalik. I’m the founder of ProFeds and will be your presenter today. We’re excited to be able to do sessions like this because I think there are a number of misunderstandings that federal employees have about various topics, taxes being one of them, hopefully we’re able to get you all on the right track today. So of course, our topic today, taxes in retirement, we want you to understand the tax implications of retiring and what steps to take today to be ready when it happens. There’s a lot to think about for today’s session.

A quick agenda, so the basic things that we’re going to cover today, we will talk about tax brackets. I know snooze fest there, but I think it’s important to understand how these brackets are working, especially as you’re preparing for retirement. Next, we’ll talk about the tax treatment. Of the federal benefits that you have, how are they going to be taxed and when? What changes at the time of retirement so that you can really see how all of this works? And then lastly, we’ll talk about some tax changes, so when to expect those significant changes in the taxability of your benefits.

Now, my favorite slide of any of these webinars is what we’re not going to cover because I think this is incredibly important just to give some framework to what we’re going to be doing today. This webinar will not cover things like giving you tax advice. We’re here to give you some tax awareness so that you can be mindful of what you’re doing today that affects your tax situation later. Of course, we’re not going to be able to cover everybody’s individual tax issues or the things that you’re going to experience in retirement. These are simply the highlights of the federal benefits that most of you have.

Like I said, we have no idea what your tax situation looks like, so we encourage you to seek professional help in developing and executing a tax strategy that suits you and your circumstances. And lastly, we’re going to assume that you have a basic understanding of the benefits. We’re not going to go into a lot of the rules on the benefits. We’re going to assume that you have some basic awareness there and then we’ll kind of go from there from a tax situation.

Taxes in General

Let’s talk about taxes in general. Of course, taxes are a very real part of retirement, and as such, they should be a really big part of your retirement planning, of your financial planning process. If you ignore the tax monster, it does not make it go away. Let me say that again. If you ignore the tax monster, it doesn’t make it go away. I say that because oftentimes, I think that taxes are an easy thing to put off because it’s complicated. You’re going to deal with it later, and then all of a sudden, the tax monster hits you on the head with the frying pan and then what are you left with? So, we have to address this, and the sooner you do it the better.

Now, next step, not all money is taxed in the same way or at the same time. We’re going to break some of this down as we go through each of the benefits, but I will tell you the most successful retirees have a solid tax strategy. If you do not have that in place, how on earth are you going to make sure that you don’t pay more tax than is absolutely necessary? We want to stay within the confines of the law. We want to follow the rules, we want to pay our fair share, but if the tax law allows for some tax advantages, we want to help you to be able to get those or at least see what they are so that you can decide whether that’s worth it or not to you.

With respect to the benefits that we’re going to cover today, we will talk about your pension, survivor benefits, that goofy thing called the FERS supplement, Social Security, and then your insurance programs, your health, life, long-term care, and then the Thrift Savings Plan. So that’s just a basic overview of what we’re going to be covering today.

Tax Brackets

All right, so let’s talk about tax brackets. The tax bracket system is kind of interesting. So here in the US we have what we call a progressive tax system, which essentially means that the tax rate goes up, the percentage of tax that you owe goes up as the taxable amount of income that you have increases. The word “progressive,” isn’t a political term. This is simply acknowledging that the term progressive refers to the way that the tax progresses from low to high the more money that you make. The result of a progressive tax system though, is that a taxpayer’s average tax, which is the amount that they paid divided by the amount that they earned is less than a person’s actual tax bracket. You’re going to see this in action here in a moment with an example, but let’s talk about what the brackets are.

We currently have seven tax brackets in the U.S. These have not changed in a little while. We don’t anticipate them changing necessarily, although I suppose anything’s possible. We’ll talk about what puts you in each of these tax brackets in a second, but each one of these brackets have four different filing statuses. You’re probably, I hope, very familiar with these because chances are, you’ve been filing your taxes for many, many decades at this point. Of course, we have single, married filing jointly, married filing separately, and then head of household. So those are the four statuses that you can file your taxes.

But when it comes to the tax brackets, like I said, there are seven of them, and based on how you file and how much you make, either separately or combined if you’re married, that will determine which bracket you fall in and ultimately how much tax you’re going to owe. Now, I don’t have a lot to share with you on this particular slide, but we got a lot of questions last time that we did a webinar similar to this about, “Well, where do I fall? Which tax bracket am I in? Does that mean all of my income is taxed at that level?” That type of thing. I want to use an example to help you understand the progressive nature of the tax brackets so that you can see how your money is taxed at different levels.

All right, so let’s look at an example of how this progressive tax is applied to a single person who has a $100,000 of taxable income. We’re just going to make this really simple. The three questions we’re going to ask is what tax bracket are they in? How much do they owe? And what is their average or what we call their effective tax rate? For this single person who makes $100,000, we are going to apply the tax rate as it progresses. We’re going to have some of the money that’s taxed at the 10% level, some of it will be taxed at 12%, some at 22 and some at 24. And the reason we’re stopping at 24 is because if you look at the second column here, the taxable income, the $100,000 of taxable income that they have is between 95,000 and 182,000.

And so that’s the highest level that their money is going to be taxed, but not all of it is taxed at the 24% level. I think it’s important to appreciate that because it does change the amount of tax that you’re thinking about having to set aside. So that 10% level, $1,100 is going to be owed, at the 12% level, a little over $4,000, at the 22%, this is a big chunk of money. This is $11,000 in taxes. And at the 24% level, because there’s just a little bit in the 24% bucket, the amount is relatively low at about $1,110. In total, this person owes $17,400 in taxes. This is of course assuming we don’t have deductions and all of those other things that we would normally think of.

They owe $17,400, which means that their average or their effective tax rate is 17.4%. It’s not 24%, it’s lower than that. I share this with you because I want you to have some awareness about how this works, but I also don’t want you to underestimate the taxes that are owed based on the income that you have. If it’s safer for you to say, “Okay, I need to put 24% of it aside,” then that’s okay too, and that way you’ll have a nice surprise at the end of the year.

All right, so next up I want to look at an example because we get this question all the time. “Chris, don’t you think I’m going to be in a lower tax bracket when I retire?” Well, here’s why you’re not going to be in a lower tax bracket. Here’s the general concept. In purple we have the final taxable pay of $100,000. Let’s say that this is the example of the person we just looked at, a hundred thousand that they’re making while they’re working. They retire, they start to receive their pension. We see that in blue. They’re going to take Social Security, they’re going to take some money from the traditional TSP, and if you’re missing $70,000 of lifestyle and you need to pull from other sources again, like turning on Social Security, starting to take money from the TSP, if all of that money is taxable, guess what? You are right back in the same tax bracket as you were before.

Now, you’ll notice I have traditional TSP on here. Many of you are familiar with and are contributing to the Roth TSP, which may alter some of this for you. It means that some of your income won’t be taxable, which is always great, but it is important to appreciate that if you want to maintain the standard of living that you have right now and you don’t want to pay the same amount of taxes, meaning you want to be in a lower tax bracket, you have to act to make that happen. It doesn’t happen by accident.

There are only two reasons that you end up in a lower tax bracket in retirement. The first is you have less money. So of course you pay less tax. Nobody wants to be in this bucket because you want the money that you have right now to be able to spend it in retirement because you have eight extra hours a day to spend money. We don’t want less money; we want more money in retirement or at least the same. The second reason that you might end up in a lower tax bracket is because you took steps now to give yourself access to money that is not taxed when you receive it later. In order to do this, this requires a concerted effort, right? You have to take action to be able to do this, to build a strategy that allows for this access to non-taxable money.

But here’s the deal, A lot of you might say, “Well, I talked to my CPA. I may even have asked him or her about this Roth conversion strategy I heard about or fill in the blank, whatever other tax strategy you might’ve heard about. And the CPA was like, “Oh, I don’t think that’s a good idea.” Here’s the deal and why I think the CPA might be the wrong person to ask. We judge our CPAs on how big of a check they make us write right now. They are afraid to tell their clients to advance some tax obligation now so that they can live more comfortably later. It’s a hard conversation for most people to have. And so, you want to be very, very careful.

CPAs, they understand the tax law. I get it. Do they understand the financial strategy that allows you to put yourself in a better situation tax-wise later? That’s why I believe that you need to be working with a CPA and a financial professional at the same time and let those guys duke it out over the strategy and what the actual outcome is going to be. And that way the CPA doesn’t feel too bad about having you stroke a bigger check if there’s some things you can do today to go ahead and pay some tax to avoid paying it later at a much larger price.

So, I share that with you just to give you a little perspective. I’ve had several CPAs in my lifetime, and they all seem to be afraid to do these strategies and you have to really push them to be able to acknowledge like, “It’s okay. I’m not going to think you’re a bad CPA if you tell me to write a bigger check this year if there’s a purpose behind it.”

Federal Pensions (CSRS & FERS)

All right, next step. Let’s talk about the federal pension. Here we’re talking about the CSRS program or the FERS program. The contributions that you make to either one of the retirement systems, CSRS or FERS, this is an involuntary contribution. It’s simply a percentage of your pay that is required of you to be able to fund your pension. We’ve got all the percentages here. Of course, we have different types of employees that pay different amounts. I won’t bore you with the numbers, but they’re here for your reference. But it is important to know that those contributions that you are making are special types of contributions.

You made those contributions with after tax money, meaning you already paid tax on that money. You did not get a tax advantage, you didn’t get a tax deduction in the year you contributed the money, you went ahead and paid the tax on it. Since you already paid tax on the money when it went in, you do not pay tax on that money when it comes out in the form of your pension. This is good news for you. That means there’s going to be a portion of your pension that is not taxable. But it’s not just you who contributes to your pension, your agency also contributes to your pension. They have their own contribution schedule that they make on your behalf. And of course, all of that money is growing both on what you and your agency contributed to the pension program.

All of this money, so your agency’s contribution and all of the growth on all of the money that’s in the account is taxable when it comes to you in the form of your pension. The part you put in comes back to you tax free, but the part the agency puts in and all of the growth on all of the money that’s in the account is all going to be taxable. Here’s the deal. At the federal level, the vast majority of your CSRS or FERS pension is going to be taxable as what we call ordinary income. This is not earned income. You do not have a job where you are earning a paycheck. This is simply a tally of all of the income that you have received in a given year called ordinary income.

That small, small, small portion of your pension that is not taxable, remember that’s the part that you contributed to the CSRS or FERS fund while you were working. That part is not going to be taxable, and I suppose that’s good news for you. But here’s the deal, OPM’s going to calculate the tax-free portion each year and when you’re getting normal tax documents, all your 1099s that you get in January each year, that number’s going to be calculated for you. As far as the taxable portion is concerned, you are going to have very, very little tax-free portion of your pension. And the reason is they calculate your life expectancy and they spread out your contributions being paid back to you over the course of your expected lifetime.

They’re going to spread out that money that you contributed over the next maybe 20 or 30 years depending on how old you are when you retire. All right. Now at the state level, the CSRS or FERS pensions are typically going to be treated as ordinary income at the state level just like they were at the federal level. But there are some retiree friendly states. There are some states that don’t tax any income for any of their residents and of course, so naturally, they’re not going to tax your pension. And then there are some states that still have income tax for the majority of income that’s in their state, but they specifically do not tax the CSRS or the FERS pension. That might be something very unique to CSRS and FERS or it might be pensions in general. Every state has the ability to write their own tax law, but either way, your pension will not be taxed in those specific states.

Let’s review just really quickly what those are. These nine states, these are states that have no income tax and therefore do not tax your CSRS or FERS pension. In states that have no income tax, they typically have higher sales tax and property tax, so they’re going to get their money some way. It just won’t be directly from your pension. Keep that in mind. Now, these 10 states, these are states that have income tax, but they’ve specifically excluded the taxation of the entire CSRS or FERS pension, no matter how high or low it may be. There’s a new one that was just added to this list. Some legislation just passed for Iowa, and so that is a new addition to this list, which is kind of cool. You will note the footer here, it does indicate that there are five states, specifically Kentucky, Michigan, North Carolina, Oklahoma, and Oregon that give a certain amount of the federal pension from being taxed. So up to a certain level they won’t tax, and then above that, they very well may.

The 10 that you have listed here, regardless of how large your pension is, the entire amount is excluded from the state income tax. You’ll always pay at the federal level, but whether you pay at the state level is determined based on where you live when you retire. When you’re thinking about where you plan to live, you want to think about all of the factors before you relocate to a particular state. You guys know, state income tax is one of many, many factors when you’re thinking about where you plan to live.

Now, at the state level, you will be taxed in the state in which you reside when you receive the money. Let’s say you live in a state that is going to tax your federal pension, but then later you move to a state that does not tax it. Then at that point, the money that you’re receiving while you live in that new state that doesn’t tax it, you will have no tax obligation at the state level. It has nothing to do with the state in which you lived when you retired. It has everything to do with the state in which you live when you receive the money. It can change each and every year. Now, many of you, we get lots of questions for folks living overseas in retirement. Of course, you know that has its own complications. You want to consider all of that fully, but I assure you at the federal level, the government is going to get their money.

Survivor Benefit Plan (SBP)

All right, next step. Let’s talk about Survivor Benefit Plan. So SBP for short. SBP is one of those things that requires a little bit of explanation. We’ll give you a little bit of a primer here. This program, the Survivor Benefit Program, allows roughly half of your pension to be protected for your spouse. When you die, half of your pension will continue to be paid to the spouse. Now, it’s going to cost you something while you’re living in retirement and that cost is roughly 10% of your pension. In order for you to continue to give 50% of your pension to your spouse when you die, you have to give up 10% of your pension while you’re living.

A couple of things we want to talk about here. Taxes on the premium you pay, so that 10% that you’re giving up of your pension, you will not pay tax on that while you have this benefit. We’ll give an example here in a minute that you’ll see the numbers kind of come to life, but whatever that 10% is, that is not reported as income to you in retirement. You’re getting a little bit of a tax break here, which is nice, I suppose. But here’s the whammy on the back end. The taxes on the benefit that your spouse is going to receive, they will pay tax on all of the benefit that they receive of your pension after you die.

So again, you get to save a little bit on tax while you’re living and paying the premium for the Survivor Benefit Plan, but your spouse is going to be fully taxed on the benefit that they receive after you die. I want to give a quick example just to put some numbers to this. Let’s say we have a FERS retiree that’s drawing $2,000 a month in their pension. As far as the taxes on the premium you pay, if we’re protecting a $1,000 a month for the spouse, right? Once you die, your spouse keeps getting half of your pension, the cost is going to be $200 a month to you, which we already know is 10% of your pension. You would be taxed on $1,800 of income, not $2,000. That’s how that works. But again, when your spouse received that $1,000 a month, it’s fully taxable at whatever tax bracket they find themselves in after you’ve passed. So, it’s not necessarily today’s tax bracket. It may be better or worse depending on their financial situation.

FERS Special Retirement Supplement (SRS)

All right, next up, we have the FERS special retirement supplement. This program allows most FERS employees who retire under the age of 62 to get this benefit that’s similar to Social Security and they’re going to get that all the way until the time that they reach age 62. This benefit is taxed as ordinary income and it’s going to be treated just like the CSRS and FERS pension at both the federal and the state level. We know at the federal level it’s all going to be taxable. At the state level though, remember there are some states that look more favorably upon CSRS and FERS annuitants and states that just flat out don’t tax any income. That same thing, those same rules would apply to the special retirement supplement.

Now, it’s important to recognize that you will not receive this benefit while the Office of Personnel Management is processing your retirement claim. This is going to be delayed, and I’m not going to get into all the details of how this is calculated and how much you can expect, but at several $1,000 a year, you just need to be prepared not to receive that until OPM is done processing your retirement claim. You will get those retroactive payments and that’s really where the tax problem comes into play. If you end up missing a bunch of special retirement supplement payments because your application for retirement is in process for a long time, perhaps OPM will pay that money to you in the next tax year. And now you start to receive your normal special retirement supplement payment, which may end up pushing you into a new tax bracket. It just depends on where you are in the bracket, how much money you have left to earn as far as what your taxable level is before you get pushed into another bracket.

Social Security

All right, next up is Social Security. We’re going to start with not the benefit you’re going to receive in retirement, but the benefit you’re paying for while you are working. We’re going to talk about Social Security and Medicare taxes or what we call FICA taxes. While you’re working, most employees contribute 6.2% of their gross pay of their earned income into Social Security and another 1.45% into Medicare. This is on new money that you are earning from an employer. Okay, 6.2% and 1.45%. Now in the federal space, we know those in the older retirement system are not contributing to Social Security and so that will look a little different for them, but everyone pays 1.45% regardless of which retirement system you might be in.

Now once you retire, those FICA taxes, that 6.2% and 1.45%, are no longer paid because you don’t have any new earned income as a retiree. You’re going to have income from your pension, but it’s not new earned income from a job. I want to make that distinction very, very important. What this ultimately means to you in retirement is that you now have the ability not to pay the 6.2% and the 1.45%, which is going to increase… Essentially your money’s going to go a little further. It’s going to increase the amount of money that you have hitting your bank account instead of some of it going to taxes. In this case, FICA taxes, not income taxes, but it’s taxes, nonetheless.

All right, as far as taxes on Social Security benefits that you receive, so this is when you begin collecting Social Security, how is that taxed? Well, at the federal level, up to 85% of your Social Security benefits are taxable. There’s a way for some people to be able to pay less than that, but as a federal worker and those of you who will be entitled to a federal pension, it will be very difficult for you to get lower than that 85% level simply because of the way the rules are written. You need to plan on 85% of your Social Security benefits that you receive as being taxable. You’re not going to pay 85% tax, it’s just the amount of benefit that you receive. 85% of that is going to be included in your taxable income for tax filing purposes.

Now, taxes are not automatically withheld. I find this very ironic that it’s a federal benefit and federal taxes are not withheld here, but you can request taxes to be withheld. On your initial application for Social Security benefits, you can indicate that you wish for taxes to be automatically withheld or later you can go back and complete the form W-4V and you can choose one of the four withholding methods that are allowable by the Social Security Administration. Okay, 7, 10, 12, or 22. Why these numbers? I’m not exactly sure how they arrived at this. They didn’t ask me, and so this is what we’ve got. All right, so that’s at the federal level.

At the state level, the states get to decide whether they’re going to tax Social Security benefits or not. In a bizarre twist, the Social Security Administration does not have the authority to withhold state income tax from the Social Security benefit. So, this is bizarre. If you happen to be in a state that requires taxes to be paid on Social Security benefits, you are going to have to make payments directly to the state. Most states ask for quarterly filings of estimated taxes that are owed, not just for this purpose, but for any type of purpose where you have extra income coming in. They don’t want you to wait until the end of the year to give them their money. They want their money along the way. So not ideal.

Perhaps another option. If you have other forms of income like your pension, like TSP, there are ways to be able to modify which bucket of income taxes are coming from. Maybe you bump up the federal on the TSP, you bump up the state withholding on your federal pension. All of those things can help offset if you don’t want to pay those directly to the state for Social Security purposes.

All right, next up, taxes on Social Security benefits. I mentioned that there are always some state exceptions on the pension, so too, are there exceptions on Social Security benefits. These are different states for the most part, but these 13 states tax some portion of the Social Security benefits. It might not be all of it, but something that you are receiving from Social Security is going to be taxed at the state level if you live in one of these 13 states. Keep that in mind.

Federal Employee Health Benefits (FEHB)

All right, next up, let’s talk about the Federal Employee Health Benefits program. Let’s talk about taxes on your FEHB premiums. Taxes are very different based on when you have this coverage in place. While you’re working, you pay your FEHB premiums with pre-tax dollars, meaning you haven’t paid tax on that money when it gets paid over to FEHB. It kind of bounces off of you and goes to your carrier, Blue Cross or Aetna or Kaiser or whoever it is that you have. But in retirement, you’re going to pay your FEHB premiums with after tax dollars, meaning you’re actually going to receive the money. Because you’ve received it, you now owe tax on it and then you still have to pay the premium to the carrier.

Now, all of this is happening kind of behind the scenes, but I want to put some numbers to this so you can really see how this works. Now, there’s a lot going on here, so follow along with me. On the example on the far right-hand side, if you are in a 24% tax bracket and you are in the Blue Cross Blue Shield, high self plus one plan, so this is the standard plan, your premium in 2023 is $8,290. If you look at that first arrow, while you were working, your pre-tax cost is $8,290. In retirement though, because you have to pay this with after tax money, meaning now we owe tax on the $8,290 that we didn’t owe before, you have to start with nearly $11,000 of income to be able to pay the 24% tax and turn around and have $8,290 to pay to Blue Cross. What this essentially means is that you have a new tax burden as a retiree, and that is $2,618.

So, the premium is the same. An employee pays $8,290, a retiree pays $8,290. So the actual premium that’s paid to Blue Cross in this example is the same, but it’s going to feel more expensive because on the premium you paid while you’re working, you don’t own any tax on it, but the premium you pay in retirement, you absolutely do owe tax to the tune of $2,600. We have to be prepared for these kinds of surprises to happen in retirement, and the more we’re prepared, the less we’re surprised.

Okay, next up, kind of an offshoot of the FEHB program. It’s worth mentioning here, and that is the flexible spending account. The healthcare flexible spending account is a really great way to set aside some pre-tax money to be used for qualified medical expenses. So many of you are already participating in FSAs and they’re great while you are working, but that is the only time they can be used. They are not available to retirees. If you retire at the end of the year, it’s typically not a big deal because you’ve exhausted whatever you’re going to pay or whatever you’re going to pay in qualified medical expenses and use that out of your FSA. But if you retire earlier in the year, you might find that you haven’t spent all your money yet, that’s in the FSA. You need to know that any remaining funds that you have in your FSA on the day that you retire are gone. They all get forfeited. It’s very, very important that you use all of your FSA money before you retire.

So, some people think that you get kind of an extension until the end of the year that you retire. That’s not true. That’s not how the FSA works. I assure you your remaining funds will be forfeited on the day that you retire. Any of those receipts, reimbursements, you need to make sure that those are submitted long before that date. It’s also worth mentioning that if whatever level you sign up for on the FSA… I don’t have this on the slide, so this is why it’s so important to listen really carefully. It’s kind of a little bit of an offshoot and it’s not really tax related, but I’ll tell you anyway.

Let’s say you max out the FSA, let’s say it’s just over $3,000 for an individual now, and let’s say that you put that away, but you retire mid-year, you still get to use the whole $3,000 or whatever level it is that you selected. Even though you’ve technically not been around long enough to contribute the full $3,000 to set aside. So, use it all. It’s all available to you. It’s totally legal, don’t worry, it doesn’t make any financial sense for the government or any entity to do this, but it’s essentially some free money that you’re able to use even if you don’t retire at the end of the year.

Federal Employee Group Life Insurance (FEGLI)

All right, the next step is the Federal Employee Group Life Insurance (FEGLI). Now, like I mentioned before, I don’t go into super great detail about how this program works, just what the tax implications are. So, taxes on FEGLI. The FEGLI program allows you to have roughly six times your salary to be paid out when you die. It’ll be paid to whomever your beneficiaries are. Let’s talk about the tax implications here. The taxes on the premiums that you pay while you’re living, you’re going to pay tax on that as normal income. You don’t get any kind of deduction or anything like that for your life insurance premiums. But the taxes on the benefit that your spouse receives, this is where life insurance is amazing. Your beneficiaries, presumably your spouse or whoever it is that you name, they will receive your FEGLI death benefit and it’s all tax-free.

Let’s say you have a half a million dollars of FEGLI coverage, you don’t get a tax benefit while you’re living, but when you die, your spouse or whomever your beneficiaries are, receive all of that money and not have to pay any income tax on it. Pretty amazing and certainly changes the trajectory of a lot of families who are grieving during that time to know that the income is there, and they haven’t found themselves in a terrible tax situation in the meantime. So, life insurance, not only FEGLI, but private life insurance works this way as well. Definitely a big thing to consider. Not much of a tax advantage while you’re working. In fact not any, but certainly the tax benefit is at the time that you die and your beneficiaries receiving that money.

Federal Long Term Care Insurance (FLTCIP)

All right, next up is the Federal Long-Term Care Insurance Program. This program allows you to elect some coverage to be paid out if you need long-term care services. For instance, if you’re not able to feed yourself, bathe yourself, dress yourself, those types of normal, what we call activities of daily living, you might need some care. This program, the Federal Long Term Care Program, allows that coverage to be paid out in the event that you need that type of care. So as far as the premium or the taxes on the premium that you pay, you will pay tax on what you pay each month to have this benefit. If you are in the Federal Long Term Care Program and paying a premium that is taxable to you now.

When the money comes out to you, when you are receiving the money from this account, you will not be taxed on any of the benefit that you are receiving when you need that care. Your premium might be a couple hundred dollars a month, you might receive several thousand a month when you need the care, and that is not taxable to you, which is pretty nice. It’s worth noting that the Office of Personnel Management has suspended the Federal Long Term Care Program. Anybody who already has coverage in place, that remains intact. So don’t freak out, but just know that no new applications are allowed through the federal program.

The insurance industry as a whole has gotten pretty creative on some pretty neat solutions to plan for long-term care purposes. I encourage you to look into that, especially now that the federal program is not taking new applications. Don’t use this as an excuse to not have a long-term care plan. We’ve got to have something in place. We’ll talk a little bit more about this towards the end of today’s webinar.

Thrift Savings Plan (TSP)

All right, next up is the Thrift Savings Plan. I know this is a hot topic for so many of you, so I want to share with you how this works. There are several tax points with respect to the TSP that we’re going to be covering today. Some taxes on your contributions into the plan, the distributions out of the plan, and then those loans that are kind of in the middle there. Then we have the concept of tax diversification, what that means, what are some steps that could be taken to put yourself in a little bit more of a diversified position. We will talk about taxes on required minimum distributions and taxes for your beneficiaries.

Let’s start with taxes on TSP, money going in and money coming out. The money going in, how you are taxed today depends on which tax bucket that you chose for your new contributions to go into. Is it the traditional TSP bucket or is it the Roth TSP bucket? You’re going to see a couple of slides here in a second that will show you the different ways that those work. Now as far as the money going out, so this is you receiving money from the TSP later, presumably in retirement. How you are taxed later depends on which tax bucket you chose to pull the money from. Did you choose to pull from the traditional bucket or the Roth bucket? That’s going to determine what kind of tax you are going to owe.

I want to start with the traditional TSP. So again, lots going on this slide. Follow along here. We’re going to start on the left-hand side. When the money goes into the traditional side of TSP, you save tax today, and that’s on the principal, the money that you are putting into the account. It’s not taxed because it’s reduced from your income this tax year, the tax year in which you are contributing it. It’s not taxed. So that principal, that blue box that you see here is not taxed. But you’ll notice if we just follow that arrow to the right-hand side when the money comes out, the principal that you put in is fully taxable when it comes out. And I think that’s the part of traditional TSP that everybody understands, “Okay, I am not taxed on it now, I’m going to be taxed later.”

But what a lot of people don’t understand is that all of the growth on your traditional TSP is going to be fully taxable too. You pay the tax later on the principal and the growth. Now presumably you’re not going to pay the tax all at one time because you’re going to take TSP distributions over presumably a long period of time. You’re going to pay it along the way, but don’t think that you’re getting some special tax break. You’re just kicking the can down the road a little bit on the traditional TSP. That’s not to say there’s not a strategy there because there is, but we have to be intentional about what we’re trying to accomplish with the traditional versus the Roth.

I want to do a similar slide for the Roth and show you the difference. With this slide talking about the tax advantages in the Roth TSP, again, starting on the left-hand side, when the money goes into the account, you do not get an immediate tax advantage. You’re going to go ahead and pay the tax on the money that you contributed to the Roth TSP. You’ll notice that that taxed arrow going into the principal, if you follow that arrow to the right-hand side, you’re going to see that it comes out tax free. If you put $100,000 in TSP, $100,000 is going to come out to you tax-free. But here’s the cool part of the Roth; the growth on all of that money that is in the Roth TSP also comes out tax-free.

Either way, whether it’s traditional or Roth, you are eventually going to pay tax on the principal either now or later. But with the growth, which typically surpasses the actual amount that someone contributed over a long period of time, the growth is far bigger than the actual principal that you contributed, which is the whole point of investing, right, that we make more money that we didn’t have to put in. But for that growth, you get to decide whether you’re going to pay tax on that growth or not. If you want to pay tax on the growth, you put money into the traditional account. If you don’t want to pay tax on the growth, you put it in the Roth account. You get to decide and kind of pick your poison a little bit.

There’s advantages on both sides, there’s negative on both sides, but you have to decide for yourself, given your bigger financial situation that you find yourselves in considering other accounts, accounts that your spouse may have, non-qualified accounts outside of IRAs or TSP or 401Ks. What that all looks like and what the strategy is that you’re trying to accomplish, that will help you to get clearer on whether traditional or Roth or a combination of both are going to be better for you. Now, I would be remiss if I didn’t circle back to the states because here, we’re talking about that federal level, but the states, there are some interesting things that happen here too. There are states who do not tax your TSP withdrawals. There are 12 of them. They are all listed here. And so again, one more thing to consider when you’re thinking about where you might live in retirement.

All right, next up, let’s talk about loans. You are allowed to take loans against your TSP account, but I would argue that doing so is really counterproductive because this is supposed to be a retirement asset and not a now asset. We want to save it for later and we don’t do that if we keep dipping into it. But let’s be real, things happen in life. If you’ve already taken a TSP loan, when you retire or you separate from service, you may now continue to pay it back or it will be declared as taxable to you. I say now because the rule just changed. It used to be that if you had an outstanding TSP loan when you retired, it was declared taxable at that time. You had 90 days to pay it back, but at that point, if you didn’t pay it back when you retired, it’s declared taxable and you owe tax on all of that money in that tax year, and it was a pretty big nightmare for a lot of people. But again, the rule has changed. So now you are permitted to continue to pay back your TSP loan even in retirement.

But here’s the deal, you need to be prepared to pay taxes twice. When you take money from a TSP loan or in the form of a TSP loan, you are going to pay tax on the money twice if you have any traditional part of your account. And I get this question, “But Chris, are you sure? That doesn’t make sense. I’m pretty sure I’m not taxed on my loan.” Well, let’s see how this works. This is a slide I pulled right over from our workshop because we needed a little bit of a visual to help people to understand really how all this works. So again, follow along with me, big blue box at the top is your traditional TSP balance. Let’s say you thought, “I don’t think I want to do that Roth thing. I just want to have traditional money in there.”

And so of course in the green box we have your contributions. Those contributions are not taxed when they go in. Remember, you’re going to pay the tax later. Eventually you’re like, “Oh man, I need $30,000 out of my TSP account.” Maybe it’s for a really good reason. Maybe it’s not for a really good reason, doesn’t really matter. You’re going to carve out $30,000. You’ll see that represented by the little dotted line in the blue box. We’re going to take $30,000 out of the TSP in the form of a loan, and even at that point it’s not taxed. The $30,000 itself is not taxed in that year in which you’re taking it.

Here’s where the sneaky tax happens. When you pay back that $30,000 loan, you’re repaying it with after tax money on money that you earned, that you have already reported as income that you paid tax on, you now take that money and make the repayment. You’re going to do that over typically many years. And so that $30,000, that principal… You’ll have paid some interest too. But for the purposes of our diagram here, we’re going to just assume your $30,000 went back into the account. In the purple when that same $30,000 is paid back to you in the form of a distribution in retirement, meaning you’re starting to take money from the TSP to live on, that distribution is going to be taxed.

You are taxed at the time of the loan repayment, and again, when that money, that same $30,000 in this example, when that is paid back to you in the form of a distribution. This is a sneaky tax, one that goes under the radar of most people, and it’s one more reason why we want you to avoid taking TSP loans if at all possible. If you don’t like paying taxes once, you’re definitely not going to pay them twice. And unfortunately, that’s what happens in this situation.

Let’s talk about this idea of tax diversification. The concept here is that there are different buckets of money to be able to choose from and that they are taxed differently in retirement. That way you get to choose when and how to take money from each of those buckets based on the situation that you are in, the tax environment that you find yourself in in retirement. We know taxes go up, they come down, it never feels like they come down, but they do. It’s going to continue to fluctuate in retirement and there may be times when taxes are low that you decide it’s more advantageous for you to take money from a taxable account and go ahead and pay your taxes on sale as they say.

You’re going to take that from a traditional styled account, whether it’s TSP or an IRA or 401K. They all work the same with respect to this situation. But when taxes are historically low, you might as well go ahead and take some of that money from the traditional side. But when taxes are really high for whatever reason, you might want to take the money from a tax-free account like a Roth. You get to pick and choose which type of account you’re going to pull from based on how the tax situation is at that time.

I share this with you because sometimes it’s advantageous to have both styles of accounts. For the TSP, I’ll share with you that everyone is going to have a traditional balance in their TSP. Everybody who is at least under FERS, you are going to have a traditional balance because you’re getting some automatic contributions from your agencies and any matching money that your agency puts into your account on your behalf. As of right now, that’s all going to the traditional side. There’s some legislation that’s allowed for that to go to the Roth side, but as of right now, it’s traditional. So even if you choose to put all of your money on the Roth side, you’re still going to have some traditional money in your account that you can decide how to strategically use in retirement. We’ve all heard of investment diversification, but I encourage you to think about tax diversification as well.

All right, next up, let’s talk about required minimum distributions (RMDs). The IRS requires by April 1st of the year following the year you turn 72, you must begin taking money from your tax deferred accounts, like traditional IRAs, TSP, and the like, and you have to pay your taxes on that money. They essentially say, “Hey, the deferment’s over. We would like you to start taking some of that money so that you can start paying some taxes on it.” So again, the traditional side of these types of accounts. We’ll talk about the Roth here in a second. The percentage of your account that you have to take is going to change each year. It’s going to continue to rise. Starting at age 72, it’s about 3.65% of your account. At 73 you’ll see it goes up slightly and it’ll continue to do so on and on and on through the lifetime expectancy table that the IRS uses to determine these numbers.

Now, we’re in a gray area, some laws have changed but haven’t gone into effect yet. I want to tell you what those are. Remember, for the traditional TSP, just like I mentioned, the required minimum distributions (RMDs) are required to be taken each year. On the Roth TSP, prior to this new legislation passing, RMDs, those required minimum distributions were required on the Roth TSP accounts. This is so bizarre because Roth IRAs in the private sector do not have required minimum distributions, meaning they can continue to grow and grow and grow and grow all tax free in retirement. You are never required to take money from your Roth account in the private sector. But that’s not how the Roth TSP has worked for a long, long time since its inception in 2012 when it came on board. Beginning in January of 2024, RMDs will no longer be required on the Roth TSP account. I’m not going to go into great detail on how it all works because pretty soon in relatively short order, we’re no longer going to have RMDs required on those accounts.

All right, so here we’re in kind of that distribution phase of the TSP and so I want to talk about something that you wouldn’t think affects or is affected by your TSP and that is Medicare costs. If you decide to enroll in Medicare Part B, those premiums that you pay are going to be based on what we call your modified adjusted gross income or your MAGI, not just income you’ve earned in a given year from an employer. Your adjusted gross income, if we look at the little table on the left-hand side, you’ll see your AGI is your gross income minus any adjustments to that income.

If we’re looking at your modified adjusted gross income, we’re going to take your AGI. We’re going to add to that any of your non-taxable Social Security benefits. Remember that other 15%, we are going to be taxed on 85% of your Social Security benefit, that other 15%, we’re going to now add that in. Then any tax-exempt interest that you have, any income that you have that’s not subject to federal income tax and then any excluded foreign income. Most of you won’t have that, but those of you who live abroad certainly will.

Adding all of that together gives us the modified adjusted gross income. What I need you to understand is in the far-left box under that AGI, this is not just your earned income, this is also income from accounts like the TSP. The money that you take from the TSP is used to determine your modified adjusted gross income, which is going to affect your Medicare Part B premium. I want to show you what it looks like. I’m going to give you a peek behind the curtain so that you see how this works. It gets a little complicated, but follow along.

All right, so the Part B premium, if you decide to enroll in Medicare Part B, this is the premium table for what you would pay in 2023. We’re going to look back two years, two tax years to your modified adjusted gross income. In 2021, we’re going to look to see how your tax return was filed. Was it an individual, a joint, or a married and separate? You find your income level and go to the far right-hand side, that is the premium that you will pay for Medicare Part B. You’ll notice that I bolded the $164 and 90 cents. I did that because that is the base Medicare premium. But you’ll see the more and more and more that you make either from an employer or your pension or Social Security or TSP, any of that income that is coming to you, that is going to increase the amount that you owe for Medicare Part B.

So gosh, if you’re a really high earner, or maybe you’re not even a high earner, but you make a decision that puts you in one of these super high tax brackets, like, “Hey, I’m going to take $300,000 out of my TSP and pay off my house.” If it’s all traditional money, guess what? It’s all in your MAGI. And so now you have inadvertently increased the amount that you owe for Part B when you otherwise didn’t need to do that. So again, a little peek behind the curtain at how all this works, but I wanted you to see the effect that the TSP and big chunks of money coming out of your TSP will ultimately have on the premium that you are paying for Medicare Part B.

All right, next up, let’s talk about taxes on the TSP after you die. All right, so we’re almost wrapped up here. This is such an important piece. I know your brains might be spinning a little bit, but I want you to pay very, very special attention to these slides. If you name someone other than your spouse as the beneficiary, when you die, they are not permitted to keep their money in the TSP. The money that you are gifting to them in the form of your beneficiary designation, they’re not allowed to just keep it there. They can choose one of two things. They can take all of the money in cash, so they’re going to pay tax on all of that money now as if they had all of that income in one single tax year because they would have. Let’s say you’ve got half a million dollars in your TSP; they get half a million. It’s as if they made half a million dollars in that year if they’re going to take it in cash.

The other option is that they could take the money from your TSP and move it to what we call an inherited IRA that allows them to take that money out over the next 10 years and spread out the tax burden and keep them from going to those super high tax brackets where you’re paying 37% of the income as taxes. Instead, if we can keep it more in the 22, 24, somewhere in there, we may be in a better situation, that person that you’re gifting this money to. This slide right here talks about naming someone other than your spouse as the beneficiary. But we know that for most of you, especially who are married, your beneficiary is going to be your spouse. So, this is the slide I need you to pay very, very special attention to. The most common beneficiary election is a spouse, which is no surprise to anyone. What would be a surprise if you don’t name your spouse and they find out later, but we’re not going to go there on this webinar.

All right, so here’s the scenario, and I’ll just use some basic examples here. Let’s say the husband is the federal employee. The wife has been named as the beneficiary to the TSP. The husband dies, the account is transferred to what we call a beneficiary TSP account. It’s still in the TSP, it’s in the wife’s name now, and it’s going to default to the L fund that’s most closely aligned with their age. They have a whole way that they do this. But remember, the money’s still in TSP in this special account. At that point, the wife is like, “Well gosh, if something happens to me, I want to make sure that my kids get this money.” So, she goes in and names the kids as the beneficiaries on this beneficiary TSP account and then she dies.

Here’s what happens. In this situation, because the money was in the wife’s name at TSP, when she dies, the kids must take all of the money in lump sum. So again, let’s say there’s a half a million dollars still sitting in that account, wife dies, the TSP says, “Okay, the next people on the list are the kids.” There’s no inherited IRA opportunity in this scenario. And so, all the kids must take the money in a lump sum, and they have to pay the taxes on it now. If we’ve got two kids, we’ve got half a million dollars in the account, they each get $250,000 and it’s as if they earned an extra $250,000 in that tax year. They’re going to have to pay all the tax upfront and it will perhaps modify some of the other tax strategies that they have that they were planning on.

So, it’s very important, and when I looked back at the questions, I saw that there was some confusion between these two slides. You’re like, “Well, on one slide you say that the kids can move it to an inherited IRA. And the other slide, you say that they have to take it all lump sum.” The difference is that in the first scenario, I’m going to back up one slide here, if you name someone other than your spouse, so let’s say your kids or nieces, nephews, brothers, sisters, whoever that might be, someone other than a spouse, the only thing they can do with it is to transfer it to an inherited IRA, other than taking the cash right now. But as far as keeping it in an account, they can’t leave it in TSP. They have to move it to an inherited IRA.

But in this slide, we’re talking about your spouse being the first person who gets it. If they leave the money in the TSP and then name the next beneficiary, that’s when all of the money has to come out lump sum. The way to avoid this is when you die, your spouse, they have a choice. They can either leave it in that beneficiary TSP account or they can move it to a spousal IRA. It’s a different type of account, but they can move that out into the private sector and then name the beneficiaries, presumably the children. And from that account, the children can then do an inherited IRA and spread out their tax burden.

These are all within the laws, the regulations that have been written around the TSP that I desperately want you to understand and appreciate that leaving it here has a direct consequence to the next beneficiaries. If your spouse doesn’t have any wherewithal, they don’t understand the difference between a beneficiary TSP account and moving it to a spousal IRA, they are likely just going to leave it here because it’s quote, easier. But if they don’t fully appreciate what happens next, then how can they make a good decision on what to do? I want you to know how this works so that you can help your spouse fully understand and appreciate what’s about to happen and be able to make a more educated decision on what happens with respect to not only the taxes, but who’s receiving the money.

Wrap-Up & Next Steps

All right, so here we are. Gosh, I know we kind of fly through these taxes, but it’s hard to get through these many different benefits and talk about the tax implications of each one. I do want to talk just briefly about, kind of this wrap up here. Each of these tax scenarios that we’ve covered today can affect one another and your overall tax obligation. Like many of you, I see in the chat, many of you are like, “Oh my gosh, these extra Medicare premiums. I had no idea that I’d have to pay more for Medicare Part B if I took more money out of my TSP.” That is something that didn’t even cross your mind. But without a tax strategy, you’re likely going to pay more in taxes than you’re supposed to. And who wants to do that? Let’s follow the rules to the best of our advantage and do all the things that are legal to avoid paying more tax than we’re required to.

All right, next up, these taxes are complicated, but you have more choices than you might think. Sometimes we think that taxes are just something that happens to us, and on some level, I suppose that’s true. But when we think about the traditional and the Roth TSP, we have choices here that we can make a lot of really good decisions, and I hope that you’ll take the time to figure out what that looks like for you to make the best decision possible. There are so many options out there to put yourself in a more favorable tax situation, so be proactive to do that. And remember, taxes are a very real part of retirement, and so they should be a very real part of your financial planning as well.

So how does this fit in the bigger picture? It’s worth it to find out. I would highly, highly encourage you if you haven’t already done so, please attend one of our in-person workshops. These are full-day sessions. We cover a lot about the benefits. Of course, not just the tax implications, but how they work, what numbers you can expect. There’s no cost to attend this workshop. These are sponsored sessions, so the cost has been picked up for all of you. And we’re going to cover all of the federal benefits topics and all of those decisions that are going to need to be made as you approach that retirement window.

But here’s the beauty of these workshops, that there is one-on-one help available after the workshop so you can schedule some time to get some clarity about your benefits. See, “Am I on track tax-wise to where I plan to be,” so that you have that tax awareness and can get a better sense of what that bigger picture really looks like. You can see all of the details of all of the workshops that we have available in these local areas by going to You can also see the link right at the bottom of the webinar portal to be able to check out for a workshop in your area.

Now for handouts and replays, of course we do still have the handouts available. So, you can either download it right from the webinar portal or if you look to the bottom of your screen, there’s a link to the handouts as well. We will be emailing you a copy of how to get the handouts as well, so the link is right to the handouts, so you’ll have that nice and handy here in the next day or so. Next step is the replay. That will also be emailed to you. You are of course welcome to pass this along to others who you think might benefit from hearing this message. So be sure to pass this along.

All right, last up is the next webinar that we’ll be conducting on August 25th. What are the odds? Planning for long-term care. We see a lot of situations where perhaps someone didn’t feel the need to have some long-term care planning or strategy in place and they end up needing care and depleting so many of their assets. And so, we wanted to walk you through just the ins and outs of long-term care planning. And we unfortunately have to do this in the absence of a government solution because like I mentioned in the previous slides, the Federal Long Term Care Program is currently suspended by OPM, so they’re not taking new applications. If you’re looking to shore up the retirement plan that you have, the actual financial strategy that you have in place, you’d be remiss not to include long-term care in that thought to make sure that you’re fully protected. And at least consider, what are the odds that you’re going to need long-term care and what’s it going to cost you?

So, you can sign up for that webinar at Same place that you signed up for the one that you’re on right now, and we’ll look forward to seeing you on August 25th. All right, thank you all so much for being here with us today for this webinar. Remember to find a workshop, you can visit and to register for next month’s webinar on planning for long-term care, you can go to All right, thank you all so much for joining us. We’ll see you next month.


Check out the workshop schedule to attend a FedImpact workshop in your area! 
Use the SF-182 to request paid time off to attend the training.

Don’t see a workshop in your city/state?
Add your name to the list to be notified when new locations and dates are announced!