Federal Tax on Retirement Pension – How it Works?

Knowing how your pension income will be taxed as you approach retirement is essential. Federal taxation on retirement pensions can be complex, so it’s crucial to grasp the rules and regulations. In this guide, we’ll cover the basics of federal taxation on retirement pensions, look at different scenarios, and provide valuable insights to help you navigate this complex landscape.

Table of Contents

What is the Federal Income Tax Rate on a Retirement Pension?

The federal income tax rate on a retirement pension is determined by your total taxable income, which includes your pension payments, social security benefits, and any other sources of income you may have. The tax rates are progressive, meaning higher income levels are subject to higher tax rates.

The federal income tax rates for the 2023 tax year vary from 10% to 37% based on your taxable income and filing status. Below is a summary of the tax brackets for your reference:

• 10% for taxable income up to $22,000 for married couples filing jointly ($11,000 for singles)

• 12% for taxable income over $22,000 but not over $89,450 for married couples filing jointly ($41,675 for singles)

• 22% for taxable income over $89,450 but not over $190,750 for married couples filing jointly ($88,000 for singles)

• 24% for taxable income over $190,750 but not over $364,200 for married couples filing jointly ($182,100 for singles)

• 32% for taxable income over $364,200 but not over $462,500 for married couples filing jointly ($231,250 for singles)

• 35% for taxable income over $462,500 but not over $693,750 for married couples filing jointly ($346,875 for singles)

• 37% for taxable income over $693,750 for married couples filing jointly ($346,875 for singles)

It’s important to note that these tax brackets are subject to change annually, so it’s always advisable to consult the latest tax guidelines or seek advice from a professional tax consultant.

Federal Tax on Retirement Income – Calculator

Utilize an online calculator for retirement income to approximate the federal tax that will be owed on your retirement income. To approximate your tax liability, these calculators consider various factors, such as your filing status, total retirement income, deductions, and credits.

Many financial institutions, accounting firms, and government websites offer free online tax calculators specifically designed for retirement income. These tools can be beneficial in planning your retirement finances and budgeting for your tax obligations.

Benefits of Federal Income Tax on Social Security Retirement 

If you are getting Social Security retirement benefits, a portion of it might be liable to federal income tax based on your total income. Your Social Security benefits may be subject to taxation based on your provisional income, calculated by adding your adjusted gross income, non-taxable interest, and half of your Social Security benefits.

When your income surpasses specific levels, as much as 85% of your Social Security benefits might be liable to federal income tax. The thresholds are as follows:

• If you’re unmarried and your provisional income falls between $25,000 and $34,000, you might be obligated to pay taxes on as much as 50% of your Social Security benefits.

• If you are single and your adjusted gross income is over $34,000, up to 85% of your Social Security benefits may be taxable.

• Suppose you are married and filing jointly; your provisional income is between $32,000 and $44,000. Notably, as much as 50% of your Social Security benefits may be subject to taxation.

• If you file jointly and are married, and your provisional income is over $44,000, as much as 85% of your Social Security benefits might be taxable.

It’s important to note that these thresholds are subject to change annually, and it’s advisable to consult the latest tax guidelines or seek professional advice to determine the exact taxable portion of your Social Security benefits.

How much is the Federal Income Tax on Military Retirement?

Military retirement pay, including pensions and disability compensation, is generally subject to federal income tax. However, certain portions of your military retirement pay may be exempt from taxation, depending on factors such as your disability rating, combat-related injuries, and the nature of your retirement.

Your military retirement pay is taxable income for federal income tax purposes. The amount of tax you owe will depend on your taxable income, filing status, and any deductions and credits that apply.

It’s important to note that some states may offer tax exemptions or special tax treatment for military retirement pay, so it’s advisable to consult with a tax professional or review the state tax regulations in your area.

List of States with no tax on federal retirement income

While federal retirement income is subject to federal income tax, some states have implemented tax policies that exempt certain types of retirement income from state income tax. 

Here’s a list of states that currently do not tax federal retirement income, including military pensions and Social Security benefits:

1. Alabama
2. Alaska (no state income tax)
3. Florida (no state income tax)
4. Hawaii
5. Illinois
6. Kansas
7. Kentucky
8. Louisiana
9. Massachusetts
10. Michigan
11. Mississippi
12. Nevada (no state income tax)
13. New Hampshire (no state income tax on personal income)
14. New Jersey
15. New York
16. North Carolina
17. Ohio
18. Oklahoma
19. Pennsylvania
20. South Carolina
21. Tennessee (no state income tax on personal income)
22. Texas (no state income tax)
23. Washington (no state income tax)
24. West Virginia
25. Wisconsin
26. Wyoming (no state income tax)

It’s important to note that state tax laws are subject to change, and it’s always advisable to consult with a tax professional or review the current state tax regulations in your area to ensure accurate information.

Conclusion

Understanding the federal tax on retirement pensions is crucial for effective financial planning during your golden years. By understanding tax brackets, calculating taxable income, and considering state-specific tax policies, you can prepare for retirement and make informed financial decisions.