How is Military Retirement Taxed?
Military personnel have earned their retirement benefits, but are they aware of the tax implications? Understanding how military retirement is taxed is crucial to make informed financial decisions. In this article, we will delve into the taxation of military retirement and provide valuable insights to help service members navigate the tax system.
Is Military Retirement Taxable?
Military retirement benefits are generally taxed, but the good news is that a significant portion of it is exempt from taxes. Up to 70% of military retired pay is tax-free (1). This is a significant benefit, and understanding how it works can help service members plan their finances more effectively.
Federal Taxes
The taxation of military retirement benefits at the federal level is complex. The Military Pension Retiree Survivor Benefits Improvement Act of 2004 (2) aimed to simplify the taxation of military retirement benefits, but it still requires service members to understand the intricacies of the tax laws.
Tax-Free vs. Taxable Components
The military retirement benefit has two components: the Tax-Free Component and the Taxable Component.
- Tax-Free Component: Up to 70% of military retired pay is exempt from federal income taxes.
- Taxable Component: The remaining 30% of military retired pay is subject to federal income taxes.
State Taxes
State taxes on military retirement benefits vary widely, with some states exempting all or part of military retired pay from state taxes. Forty-seven states exempt all or a portion of military retired pay from state income taxes (3). However, it’s essential to review your state’s specific tax laws to determine the exemption percentage.
How are Military Retirement Benefits Taxed?
Here’s an example to illustrate how military retirement benefits are taxed:
Suppose a service member has a military retirement pay of $50,000 per year. The taxable portion would be $15,000 (30%), which would be subject to federal income taxes. The tax-free portion would be $35,000 (70%), which would be exempt from federal income taxes.
Tax-Deferring Strategies
Service members can employ tax-deferring strategies to minimize their taxable income. Here are some ways to do so:
• Contribute to a Thrift Savings Plan (TSP): Contributions to a TSP are tax-deferred, which means you won’t pay taxes on the earnings until you withdraw them in retirement.
• Maximize the 70% Tax-Free Component: Ensure you’re receiving the maximum tax-free component of your military retirement pay by ensuring you’re eligible and submitting the necessary paperwork to your personnel office.
• Consider a Roth Individual Retirement Account (IRA): Contributions to a Roth IRA are made with after-tax dollars, which means you’ve already paid taxes on the contributions. Withdrawals are tax-free.
Other Tax Considerations
Service members should be aware of other tax considerations, such as:
• Moving Expenses: When moving due to a PCS, you may be able to deduct moving expenses from your taxable income.
• Disability Benefits: Disability benefits received from the VA may be tax-exempt, but it’s essential to consult with a tax professional to determine the tax implications.
• Roth IRA Conversions: Service members can convert a traditional IRA to a Roth IRA, which can help minimize taxes in retirement.
Conclusion
In conclusion, understanding how military retirement is taxed is crucial to make informed financial decisions. Service members should familiarize themselves with the taxation of military retirement benefits and take advantage of tax-deferring strategies to minimize their taxable income. By understanding the tax implications, service members can better plan for their financial future and achieve a more secure retirement.
Table: Taxability of Military Retirement Benefits by State
| State | Exemption Percentage |
|---|---|
| Alabama | 100% |
| Alaska | 25% |
| Arizona | 50% |
| Arkansas | 75% |
| California | 25% |
| Colorado | 50% |
| Connecticut | 100% |
| Delaware | 75% |
| Florida | 100% |
| Georgia | 25% |
| Hawaii | 75% |
| Idaho | 50% |
| Illinois | 50% |
| Indiana | 25% |
| Iowa | 75% |
| Kansas | 100% |
| Kentucky | 50% |
| Louisiana | 25% |
| Maine | 50% |
| Maryland | 75% |
| Massachusetts | 75% |
| Michigan | 25% |
| Minnesota | 50% |
| Mississippi | 50% |
| Missouri | 75% |
| Montana | 100% |
| Nebraska | 75% |
| Nevada | 50% |
| New Hampshire | 100% |
| New Jersey | 100% |
| New Mexico | 50% |
| New York | 100% |
| North Carolina | 75% |
| North Dakota | 50% |
| Ohio | 50% |
| Oklahoma | 100% |
| Oregon | 50% |
| Pennsylvania | 50% |
| Rhode Island | 75% |
| South Carolina | 25% |
| South Dakota | 50% |
| Tennessee | 25% |
| Texas | 100% |
| Utah | 25% |
| Vermont | 75% |
| Virginia | 50% |
| Washington | 25% |
| West Virginia | 75% |
| Wisconsin | 75% |
| Wyoming | 100% |
Please note that this table is not exhaustive and is subject to change. It’s essential to consult with a tax professional or your personnel office to determine the exact tax implications of your military retirement benefits.
