It is common knowledge that American military veterans receive plenty of benefits. Serving in the U.S. military is an honor, after all. Veterans are entitled to many perks, from housing loans, healthcare education benefits, and discounts in retail establishments and restaurants. One of the most significant benefits of active service is military retirement pay.
Given how the federal government provides many benefits to veterans, is their retirement income considered taxable income? We’ll discuss common misconceptions on military retirement income and taxes. You’ll find out if the government taxes military retirement pay or not.
- 1 Understanding Military Retirement Pay
- 2 Myth vs. Reality On Military Retirement Pay
- 3 What Is The Federal Tax Rate On Military Retirement Pay?
- 4 Why Is Military Retirement Taxed So High?
- 5 State Tax Considerations
- 6 Military Retirement Tax Haven States
- 7 Social Security Benefits and Military Retirement
- 8 Combat Zone Tax Benefits
- 9 Additional Factors Affecting Taxable Income
- 10 Essential Tax Forms and Resources
- 11 Tips for Managing Taxes in Retirement
- 12 Conclusion
- 13 FAQs
Understanding Military Retirement Pay
Before we dive into federal taxable income, you should understand military retirement pay. Military retirement pay is one of the most attractive benefits of serving in the U.S. military. There are two ways to qualify for these benefits. Service members who served on active duty in the U.S. Army, Air Force, Navy, Marine Corps, or Coast Guard for at least 20 years are the primary recipients of this payment. Military personnel who have retired earlier for medical reasons are also given this compensation privilege.
Not all military retirement pay systems are the same. There are four types of regular retirement systems and one irregular one. The veteran’s Date of Initial Entry into Military Service (DIEMS) determines which of the four systems they qualify for. Moreover, the retirement income amount and requirements depend on whether a Soldier qualifies for active duty or non-regular retired pay.
The first system is the Final Pay Plan, which covers individuals who entered military service before September 8, 1980. Under this system, military retirement pay is computed using 50% of a person’s basic income after two decades of service plus 2.5% for each additional year. This plan also includes a Cost-of-Living Adjustment (COLA) usually on an annual basis.
The second system is the High-36 plan, which covers service members who entered into the military between September 8, 1980, and July 31, 1986. Under this system, one’s retirement income is computed using 50% of the average of the ‘high-36’ or 36 months of basic pay after two decades of service plus 2.5% for each additional year. This plan also includes a Cost-of-Living Adjustment (COLA) usually on an annual basis.
The third system is the most popular one, the Career Status Bonus Payment (CSB) or REDUX. This system covered people who entered the military on or after August 1, 1986, and before January 1, 2018. Under this system, retirees have two options. As explained, their first option is to retire under the ‘high-36’ plan.
Their second option is to retire under the Military Retirement Reform Act (MRRA) provisions or REDUX. Under REDUX, service members can receive a $30,000 Career Status Bonus (CSB) after rendering 15 years of service and agreeing to complete 20 years. It should be noted that this retirement system is voluntary.
The fourth system is called the Blended Retirement System (BRS). This system covers individuals who entered into service after January 1, 2018. Under this system, covered members receive a government contribution equal to one person of their basic or inactive duty pay to a tax-advantaged retirement account (Thrifts Savings Plan or TSP). This is activated 60 days after they enter into uniformed services. In addition, these personnel may receive up to an additional 4% matching contribution from the government to their TSP from the beginning of their second year until their 26th year.
Under the BRS, service members who qualify for retirement based on longevity will also receive a defined benefit, twice the number of years of service time, and their highest 36 months of basic pay.
The fifth system is special, as only individuals who are medically unfit for continued service with a DoD disability rating of at least 30% are qualified. This is the disability retirement plan. Under this plan, the pay is equivalent to one’s retired pay base multiplied by a specific multiplier. That individual’s DIEMS determines their retired pay base. Meanwhile, the multiplier can either be that member’s percentage of disability determined by the military service or years of creditable service times 2.5% or 2.0%. The multiplier is limited to 75% only in both cases.
Myth vs. Reality On Military Retirement Pay
Various myths surround military pensions. For example, some think military retirement pay isn’t subject to federal income tax. While some aspects of retirement benefits may be tax-free, some components may be subject to taxation. Depending on where you live, you may be required to contribute state income tax.
Another common myth surrounding military retirement pay is that retired service members won’t be around long enough to enjoy their retirement benefits. However, the reality is that some Americans live up to 90 years old.
There’s another misconception that taxes on military retirement are significantly lower than regular income tax. The reality is that the enormous government deficits make tax increases more likely in the future.
What Is The Federal Tax Rate On Military Retirement Pay?
So, how much tax does a military veteran have to pay? It varies from person to person. Military retirement pay based on a person’s age and service length is taxable and should be included as income for federal income taxes. Meanwhile, the amount a veteran pays to participate in the Survivors Benefit Plan (SBP) is part of federal income tax exclusions. For Social Security tax purposes, military retirement pay doesn’t count as earned income. No Social Security payroll taxes are withheld from one’s military retirement pay.
Meanwhile, Military Disability Retirement Pay, which is received as pension income for personal injury or sickness resulting from active service in the armed forces, is part of federal income tax exclusions. This is provided that the following conditions apply:
- That person was entitled to disability payment before September 25, 1975
- That person was a service member (active or reserve) or was under a binding written commitment to become a service member on September 24, 1975
- That person received disability payments because of a combat-related injury
Moreover, veterans’ benefits are also excluded from one’s federal taxable income. The following benefits veterans are entitled to aren’t subject to federal taxes:
- Insurance dividends left on deposit with the V.A.
- Education, training, and subsistence allowances disability compensation
- Disability compensation and pension income for disabilities paid to veterans or their families
- Payments given under the compensated work therapy program
- Homes designed for wheelchair living grants
- Motor vehicles for veterans who lost their sight or use of limbs
- Dependent care assistance program benefits
- Death gratuity paid to an Armed Forces survivor who died after September 10, 2001
- Any bonus payment offered by a political subdivision because of service in a combat zone
- Veterans’ insurance proceeds and dividends paid to them or their dependents
Suppose you retire from the Army based on service length and are later given a retroactive service-connected disability rating by the V.A. Your military retirement pay is excluded from income tax up to the amount of the V.A. disability benefits you would have obtained. In addition, you can claim a refund on taxes paid on the excludable amount through an amended return on Form 1040x for each previous year during the retroactive period. This refund is subject to the statute of limitations.
At the same time, you may exclude 100% of any severance benefit from your income if you’re given a lump-sum disability severance payment and are awarded V.A. disability compensation later. On the other hand, any lump-sum readjustment or severance payment unrelated to disability must be included in your income.
Why Is Military Retirement Taxed So High?
Military retirement pay is taxed so high primarily because of the massive debt the government has incurred. Veterans receive numerous impressive benefits, some of which are exempted from tax. Moreover, disability compensation is exempt from taxable income, which should be considered when a veteran is computing taxes. However, these benefits are provided by the Department of Defense, and taxpayers fund this department.
Hence, taxes on military retirement are necessary for veterans to enjoy their benefits and for the government to continue functioning. These taxes help fund public schools, libraries, and other public services. The taxes collected from military pensions can benefit more people in the long run. Hence, it is necessary to tax military retirement pay.
State Tax Considerations
It’s been stated that military retirees pay income tax, but the amount isn’t always the same in all U.S. states. Some states offer partial taxation rules or no special tax benefits to veterans’ military retirement pay. Select states may not require higher tax rates for retirement income but include them partially or fully in your taxable income like all other income sources.
These are the states that tax military retirement income partially through income exemptions and exclusions:
- West Virginia
- South Carolina
- New Mexico
The District of Columbia also requires partial tax payment, but this benefit extends to individuals 55 or older. While the states above don’t tax military retirement pay, it should be noted that retirees should consider a state’s total tax burden before planning to relocate. One should consider the overall tax implications of relocating to another state.
Moreover, select states provide little to no tax benefits to retirement pay and will tax military retirement pay in full:
- Rhode Island
Military Retirement Tax Haven States
In addition, select states don’t impose taxes on military retirement pay. The following states are considered military retirement tax havens:
- North Dakota
- North Carolina
- New York
- New Jersey
Some states don’t have income tax altogether. These states include the following:
- South Dakota
New Hampshire is a unique case because this state charges state income taxes on dividends and interest income only.
Social Security Benefits and Military Retirement
Another vital aspect to understand about military retirement pay as taxable income is that one’s military retirement doesn’t affect one’s social security benefits. A person receives social security benefits based on their earnings.
Notably, the Full Retirement Age (FRA) for most current service members on active duty is 67. However, retirees can claim their Social Security benefits once they reach 62 years old. When a person claims before their FRA, they are considered to be ‘claiming early.’ The benefit is reduced according to the period before their FRA.
Moreover, Social Security benefits are taxable, which can be challenging for veterans who are to receive a monthly pension for life. The monthly pension payment for most retirees will likely make 85% of Social Security benefits taxable.
The calculation for the taxability of Social Security benefits is complex. Here are the key numbers to note:
- Pension income of more than $32,000 for married filers
- Pension income of more than $25,000 for single filers
Moreover, military veterans should take note of the Windfall Elimination Provision (WEP). This provision in the law alters how a person’s Social Security benefits are calculated. WEP can reduce a person’s retirement or disability benefits if they received the pension payments from work and did not pay Social Security taxes on those earnings. Thus, the military pension veterans receive from Social Security benefits can be reduced, affecting a veteran’s retirement living.
Combat Zone Tax Benefits
Another interesting aspect of military retirement pay is the Combat Zone Tax Exclusion (CZTE). Service members who served in a combat zone can exclude certain payments from their taxable income. The CZTE is considered unlimited for enlisted members and warrant officers. Moreover, it is limited to the maximum enlistment payment amount in addition to the amount of Hostile Fire Pay / Imminent Danger Pay payable to the officer for the qualifying month for officers.
It should be noted that just because an individual served in a combat zone doesn’t mean they’re exempted from income tax forever. This tax exclusion only applies to any period wherein that service member was in a combat zone or qualified hazardous duty area.
Additional Factors Affecting Taxable Income
But what if the military veteran died and didn’t get to enjoy their military retirement pay? This is where the Survivor’s Benefits Plan comes in. This plan ensures a continuous lifetime annuity for veterans’ dependents. It provides eligible survivors with an inflation-adjusted monthly income.
Military retirees have to pay premiums to get SBP coverage upon retirement. Premiums are deducted from gross military retirement pay and don’t count as income. Hence, a premium implies less tax and less out-of-pocket costs for SBP. Moreover, the government partially covers these premiums and absorbs the program’s costs, so the average premiums are well below the price of a conventional insurance policy.
Moreover, a spouse’s maximum SBP annuity is 55 percent of the retiree’s retirement pay. For individuals who retired under REDUX, the retired pay the member would have received if under the high-three retirement system.
It should be noted that SBP premiums reduce a military retiree’s taxable income and can reduce out-of-pocket costs for coverage. SBP benefits are taxed as the survivor’s income. However, the tax rate upon annuity receipt will be less than the member’s current tax rate.
These deductions and exemptions are vital in how a retiree enjoys their military retirement pay. This entails more money to provide for their loved ones and enjoy a comfortable retirement.
Essential Tax Forms and Resources
Fortunately, accessing tax forms and resources has become more readily available to military retirees. Regarding military retirement pay as income tax, the most vital government form is the Form 1099-R. This form is a variant of Form 1099, which is used to report contributions from annuities, pensions, IRAs, retirement or profit-sharing plans, charitable gift annuities, and Insurance Contracts.
In most cases, electronic online forms are available through the myPay website. Retirees with Form 1099-R reissue requests can access this website. To learn more about taxes on military retirement pay, you can refer to the Defense Finance and Account Service or Internal Revenue Service website.
Tips for Managing Taxes in Retirement
Understandably, most military retirees would like to maximize their military retirement pay. There are various ways to minimize tax liabilities upon retirement and enjoy one’s military pension. For example, it would be an excellent idea to diversify one’s retirement income. Once a service member is in retirement and drawing from their savings, diversification can help them manage their taxable income and tax bracket.
Another strategy retirees can explore is to delay withdrawals if they’re still in a higher bracket. While it’s possible to withdraw money savings at 59 and a half and claim Social Security as early as 62, it would be wise to delay both if they’re still working and not in need of the money. This can help them avoid higher income tax rates on withdrawals.
Navigating through income tax on military retirement pay can be challenging. This is where tax professionals who specialize in military tax matters come in. These experts can provide excellent advice in income tax exemption and beyond to maximize one’s military pension.
Dealing with taxes can be particularly challenging for military retirees. Understanding the tax implications of military retirement pay is essential for planning a stable financial future. Knowing how to navigate this specialized area allows retirees to optimize the benefits accrued from years of service. If uncertainties arise, consulting with tax professionals experienced in military matters can provide invaluable guidance.
For a comprehensive grasp of military life and benefits, Military Verification is a reliable resource. Don’t hesitate to delve deep into our website to equip yourself with essential information and for your military verification needs.
What is the Military Pension Federal Tax Rate?
Tax obligations for military retirees can differ significantly based on individual circumstances, such as length of service. While federal taxes apply, some states offer exemptions or exclusions on military retirement income. It’s essential for retirees to understand these nuances, and possibly consult tax professionals, to maximize the financial benefits of their service.
Is Retirement Pay Taxable?
Federal law subjects military retirement pay to taxation, but some states offer exemptions or do not tax it at all. Understanding these geographic differences in tax treatment is crucial for military retirees looking to optimize their financial planning. It’s often advisable to consult a tax expert familiar with military retirement benefits for tailored guidance.
Is Military Retirement Taxable if 100% Disabled?
Disability compensation for veterans is generally nontaxable, but military retirement pay is subject to taxation. It’s crucial for veterans to understand this distinction to manage their finances effectively. Seeking advice from a tax professional familiar with military benefits can provide further clarity and optimize financial planning. Being aware of these tax nuances can help veterans make informed decisions about their post-service lives.