Federal Retirement Tax Planning: How Your FERS Pension, TSP, and Social Security Are Taxed

Your Federal Retirement Income Will Be Taxed — But How Much?

After decades of federal service, you’ve built a retirement income from three powerful sources: your FERS pension, your Thrift Savings Plan (TSP), and Social Security. Together, they form a solid financial foundation — but each one is taxed differently, and without careful planning, you could end up paying significantly more in taxes than necessary.

Tax planning is one of the most overlooked aspects of federal retirement preparation. The decisions you make in the years before and after retirement — when to withdraw from the TSP, which account type to tap first, how to manage your income brackets — can save you tens of thousands of dollars over the course of your retirement.

At Fed Pilot’s free retirement workshops, we walk through these strategies in detail. Here’s what you need to know.

How Your FERS Pension Is Taxed

Your FERS annuity is treated as ordinary income by the IRS. It’s taxed at your regular federal income tax rate, just like the salary you earned while working.

However, there’s a small tax-free component. During your federal career, you contributed to the FERS retirement fund — either 0.8%, 3.1%, or 4.4% of your salary depending on when you were hired. Since those contributions were made with after-tax dollars, you’ve already paid tax on that portion.

OPM calculates a “tax-free” portion of each monthly annuity payment that represents the return of your after-tax contributions. This is determined by dividing your total contributions by your expected number of retirement payments (based on actuarial life expectancy tables). Once you’ve recovered all your contributions — typically within 20 to 30 years of retirement — your entire pension becomes fully taxable.

For most retirees, the tax-free portion is relatively small — perhaps $100 to $300 per month — so the vast majority of your pension is subject to federal income tax from day one.

State Tax Considerations

Your FERS pension may also be subject to state income tax, depending on where you live. Several states are particularly favorable for federal retirees. States with no income tax include Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Some states exempt all or part of government pensions, including Illinois, Mississippi, and Pennsylvania.

Other states tax retirement income fully. If you’re considering relocating in retirement, state tax treatment of your pension should be part of the equation.

How Your TSP Withdrawals Are Taxed

TSP taxation depends entirely on which type of account you’re withdrawing from — traditional or Roth.

Traditional TSP

Withdrawals from your traditional TSP balance are taxed as ordinary income — every dollar you withdraw is added to your taxable income for that year. This includes both your original contributions (which were tax-deferred) and all investment earnings.

If you withdraw $40,000 from your traditional TSP in a given year, that $40,000 is added on top of your pension and any other income. Depending on your total income, this could push you into a higher tax bracket.

The TSP withholds 20% for federal taxes on most withdrawals by default, but your actual tax liability may be higher or lower depending on your total income for the year.

Roth TSP

Roth TSP withdrawals are tax-free — both your contributions and your earnings — as long as two conditions are met: you are at least 59½ years old, and it has been at least 5 years since your first Roth TSP contribution.

This makes Roth TSP a powerful tool for managing your tax bracket in retirement. Need extra cash for a home repair or a family vacation? Pulling it from your Roth TSP doesn’t add a penny to your taxable income.

Required Minimum Distributions (RMDs)

Starting at age 73 (under current law), you must take Required Minimum Distributions from your traditional TSP — whether you need the money or not. The amount is calculated based on your account balance and IRS life expectancy tables.

If you fail to take your RMD, the penalty is steep: 25% of the amount you should have withdrawn (reduced from the previous 50% penalty). RMDs apply to traditional TSP only — Roth TSP accounts in the TSP are also subject to RMDs, though you can avoid this by rolling your Roth TSP into a Roth IRA before RMD age.

How Social Security Is Taxed

Many federal employees are surprised to learn that Social Security benefits can be taxed. Whether — and how much — depends on your “combined income,” which the IRS defines as:

Adjusted Gross Income + Tax-Exempt Interest + 50% of Social Security Benefits

For single filers, if your combined income is between $25,000 and $34,000, up to 50% of your Social Security benefits may be taxable. Above $34,000, up to 85% may be taxable.

For married filing jointly, the thresholds are $32,000 to $44,000 (50%) and above $44,000 (85%).

Here’s the reality for most federal retirees: with a FERS pension plus TSP withdrawals plus Social Security, you will very likely have combined income above these thresholds. That means up to 85% of your Social Security benefits will be taxable as ordinary income.

Important note: this doesn’t mean you pay 85% tax on Social Security. It means 85% of your Social Security benefit amount is added to your taxable income and taxed at your regular rate.

Five Tax Planning Strategies for Federal Retirees

1. Roth Conversions Before Retirement (or in Early Retirement)

If you retire before claiming Social Security, you may have a window of lower income — perhaps just your pension, before TSP withdrawals and Social Security kick in. This is an ideal time to convert traditional TSP or IRA funds to a Roth account.

Yes, you’ll pay taxes on the conversion now, but the funds grow tax-free in the Roth and future withdrawals are tax-free. This can significantly reduce your RMDs and your overall tax burden in later years.

2. Manage Your Tax Bracket Year by Year

Instead of taking large lump-sum TSP withdrawals when you need them, consider spreading withdrawals across years to stay within a lower tax bracket. If the top of the 22% bracket is at $96,950 (married filing jointly in 2025) and your pension plus Social Security puts you at $75,000, you could withdraw up to $21,950 from your traditional TSP and stay in the 22% bracket — rather than taking $60,000 in one year and pushing into the 24% or 32% bracket.

3. Use Roth TSP Strategically

In years when you need more income — a major purchase, medical expenses, travel — consider pulling from your Roth TSP instead of your traditional balance. This keeps your taxable income lower, which can reduce the taxation of your Social Security benefits, lower your Medicare Part B premiums (which are income-based through IRMAA), and keep you in a lower tax bracket.

4. Coordinate TSP Withdrawals with Social Security Timing

If you retire at 60 but delay Social Security until 67 or 70, you can use those interim years to take traditional TSP withdrawals at a lower tax rate (since you’re not yet adding Social Security income). Once Social Security starts, you shift to Roth withdrawals or reduce traditional TSP draws to manage the combined tax impact.

5. Consider State Tax Implications When Choosing Where to Live

Relocating to a state with no income tax or favorable pension tax treatment can save you $3,000 to $15,000+ per year, depending on your income level. This is a significant factor that many retirees don’t consider until after they’ve already retired.

The IRMAA Trap: How Income Affects Medicare Premiums

One often-overlooked tax consequence involves Medicare Part B premiums. If your modified adjusted gross income exceeds certain thresholds, you’ll pay higher Medicare premiums through Income-Related Monthly Adjustment Amounts (IRMAA).

For 2025, the standard Part B premium is $185.00 per month. But if your income exceeds $106,000 (single) or $212,000 (married filing jointly), your premium increases — potentially to over $500 per month. A large TSP withdrawal in a single year can trigger IRMAA surcharges for the following year or two.

This is another reason to spread out traditional TSP withdrawals and use Roth funds strategically.

What About the Tax-Free Portion of Your Pension?

As mentioned earlier, a small portion of each FERS annuity payment is tax-free because it represents the return of your after-tax contributions. OPM will include this information on your 1099-R form each year.

If you contributed at the 0.8% rate over a 30-year career with an average salary of $80,000, your total after-tax contributions might be approximately $19,200. Spread over your expected retirement payments, this works out to roughly $65 to $80 per month in tax-free pension income. It’s a modest benefit, but it’s worth tracking for accurate tax filing.

Don’t Wait Until April 15 to Think About Taxes

The best time to start federal retirement tax planning is when you start your federal service.  But if you are far past that, don’t longer than 3 to 5 years before you retire. Many of the most effective strategies — like Roth conversions and bracket management — require advance planning to execute well.

Waiting until you’re already retired limits your options. And making mistakes with TSP withdrawals or Social Security timing can be costly and, in some cases, irreversible.

Register for a free Fed Pilot retirement workshop to learn how tax planning fits into your overall federal retirement strategy. We cover real scenarios showing how different withdrawal strategies and timing decisions affect your actual tax bill — not just the theory, but the dollars and cents.

You’ve spent your career in service to the country. Make sure you keep as much of your hard-earned retirement income as the law allows.