The people who have military careers will get various numbers of benefits and a high retirement income also. And the veterans who have served more than 20 years of service in the military will get decent retirement payments that give financial stability after working life. However, it is often seen that the military retirees face higher tax implications on retirement income than other retirees. In this situation, people wonder, Why is military retirement taxed so high. And finance is an important part of one’s life; this concern seems valid.
Some underlying rules and norms differ in the taxation of military retirement payments. Let’s discuss this topic.
What is Military Retirement Pay?
Like other retirement pay, the military retirement payment is a type of pension that is provided to individuals who have served in the Armed Forces after completing a certain number of years of service (Mostly 20 or more). The pension amount highly depends on the years of service and the rank you have achieved in the military. People often ask, Is military retirement taxable? Also, the military retirement payments are taxable by the federal tax rules and by the states.
Types of Military Retirement
There are various types of military retirement payments present, which differ only based on the tax implications:
- Final Pay System: In this type of payment system, the retirement income is calculated based on the service person’s salary at the time of retirement.
- High-36 System: This is an organized system where the retirement payments are defined based on the highest 36 months of basic pay of the serviceman.
- Blended Retirement System (BRS): As the name suggests, it is a blended system, which combines the defined pension with the contribution in a Thrift Savings Plan (TSP), similar to a 401(k).
The pension model may differ based on the rank and the salary packages, but the basic structure is the same as the above-mentioned types. These pension types get differentiated based on the tax implications.
Why Is Military Retirement Taxed So High?
The military retirement payments fall into a tax bracket due to the federal as well as state tax laws. There are many reasons why military pensions are taxable.
Federal Taxation Rules
The military pension comes under the Internal Revenue Service (IRS), which considers it as ordinary income. Some pension or retirement income systems are either partially or fully falls out of taxation. But the military retirement payments are fully covered with federal and state tax implications.
The military retirement payments are fully subject to federal income tax, where the defined deductions are made.
State Taxation
The tax implications at the state level are different, with several variations. This varies state-to-state, based on the respective tax rules:
- States That Tax Military Retirement: There are some states, like California, New Jersey, and Montana, that apply tax on military retirement payments.
- States That Offer Partial Exemptions: States like Illinois and Pennsylvania offer partial tax benefits and only tax the remaining partially retirement income of the serviceman.
- States That Fully Exempt Military Retirement: There are some best states for military retirees, like Florida, Texas, and several other states that do not apply any taxation on the military retirement payments.
The states that fully exempt military retirement offer a significant financial advantage to retirees. And in the states, where the federal and state income taxes combine and apply to the retirees will lead to a serious tax bracket that impacts the retirement pay notably.
Lack of Pre-Tax Contributions
The military pensions are not the same as some other pension systems, which are funded by contributions from employees’ salaries. The military pension is provided directly by the government to the serviceman man which is also taxable. The retirement payments for the military man are funded entirely from general appropriations.
Inflation Adjustment Limitations
The military retirement pays offers inflation adjustments through cost-of-living adjustments (COLA) to counter inflation. This is a good feature to maintain financial stability in any such financial crisis. Also, the annual tax bills increase with time, which leads to a higher tax bracket over time.
Comparing Military Retirement to Civilian Pensions
There is a common question: Why is military retirement taxed so high? which arises when talking about the military retirement. However, understanding this requires knowing the difference between a regular pension and a retirement pension.
- Funding Methods: This is one of the major differences between civilians’ pensions and military pensions. In normal cases, the pensions are first contributed into a special account like a 401(k) by the employee from their monthly income. However, the military retirement pay is fully funded by the government, so it is also fully taxed.
- Social Security Integration: Many citizens receive Social Security benefits, which are partially exempt from income tax, but military retirees face a limitation in Social Security benefits according to their service.
- State-Specific Laws: The tax implications also differ state-wise. Most state do not provides any tax relief for military pensions but offer significant advantages for other general retirement benefits.
The military pension is like a complementary money which is directly provided by the government or the military departments to all the eligible persons with the desired service years.
How to Reduce Military Retirement Taxation?
The military retirement is indeed taxable, but some tips can help reduce the overall annual tax bracket for a person. Lowering the tax burden will help in smart financial planning and empower savings.
Relocating to Another State
If possible, then relocate to another state that offers tax advantages to the military retirees. There are many states, such as Florida, Nevada, and Texas, that provide tax exemptions, and with this, you can save a significant tax amount.
Maximize Deductions
The military retirees can claim the standard deduction at the time of filing their annual income tax to reduce the overall taxable income. Also, there are some Itemized Deductions like mortgage interest, medical expenses, or charitable contributions, which can further reduce taxable income. If the retirees have contributed to any retirement savings account, then they can qualify for credits such as the Saver’s Credit.
Invest in Tax-Deferred Accounts
Military retirement payments are always taxable, so to manage this, invest in growth-oriented retirement saving accounts like IRAs, Roth IRAs, and TSPs. Which can offer tax advantages and tax-free growth. So, having profits for the loss will balance the tax implications.
Timing of Income
It is very important to plan the pension or retirement withdrawals before starting to make distributions. This will help in managing and reducing the overall federal tax brackets. If you spread the income into several years, then the per-year tax rates may be reduced. Also, delaying the withdrawal will help in lowering the current tax implications.
It is very important to consult with an expert financial advisor who has similar work experience to get the best decision-making capability. Also, it is very important to understand the state and federal taxation for military servicemen to plan for retirement accordingly. With this, the question, Why is military retirement taxed so high, is answered.
Disability Compensation and Military Retirement Taxation
The military retirement payments are indeed taxable, but this is different with military veterans who are disabled. In such situations, the tax department offers some compensation and tax benefits to them. These benefits will provide significant tax relaxations.
- VA Disability Taxations: The VA disability compensation is not taxable at any level of the department. The individual who is associated with this can have tax-free disability compensation based on the severity of the disability. Also, this income is not counted in the monthly gross income, which means it does not affect the annual tax returns.
- Concurrent Retirement and Disability Pay (CRDP): If a person is eligible for both the retirement plans, military retirement pay, and VA disability compensation, then they can also be qualified for the Concurrent Retirement and Disability Pay. With this, they can have the retirement income without having any reduction due to the other. However, the military retirement pay is still taxable.
- Combat-Related Special Compensation (CRSC): This plan is only available for veterans who have combat-related disabilities. It provides the extra compensation to the veteran, combined with the military retirement income, with a tax-free advantage.
Conclusion
Why is military retirement taxed so high? This is a valid concern that arises in the minds of people with military service history. Unlike general pensions, which are first funded from the employee’s monthly income, the military retirement pays are fully provided and funded by the government. These payments are counted in the gross annual income, which is taxable.
There are some ways that can help you reduce the tax implications of military retirement income, and for disabled veterans, there are many plans that provide tax-free retiree pay.
Frequently Asked Questions
Is military retirement taxed at a higher rate?
Yes, the military retirements are taxable with higher tax rates than the other pension plans. It is because the military retirement is like compensation money, which is fully funded by the government. This meaning the government provides this income, unlike other pension plans, where the employee first contributes some amount every month, then at the time of retirement, the pension starts from those contributions.
Is military retirement tax-free if 100% disabled?
Yes, if a veteran is 100% disabled, then they are qualified for the VA disability and other programs that offer tax-free retirement payments. Also, if the person is eligible for both retirement pay and disability compensation, then they can receive both, but the retirement pay is still taxable.
