How the IRS Taxes the Surviving Spouse Benefits of Deceased Federal Employees and Annuitants
Ed Zurndorfer –
Unfortunately, over the years there have been married federal employees who died while in federal service or after they have retired from federal service. This column discusses the tax rules affecting surviving spouses of deceased federal employees and for spousal survivors of deceased annuitants.
Employee Earnings and Unused Annual Leave Hours
Salary or wages earned by a deceased federal employee and paid to the employee’s surviving spouse (as a result of the surviving spouse being named as the designated beneficiary via Form SF 1152) after the employee’s death is considered “income in receipt of a decedent”. As such, the income is considered taxable income to the surviving spouse in the year of receipt. Besides earned wages, any unused annual leave hours the employee had at the time of his or her death and paid in a lump sum to the surviving spouse, is fully taxable to the surviving spouse in the year it is received.
Dependents of Public Safety Officers
The Public Safety Officers’ Benefits program, administered through the Bureau of Justice Assistance, provides a tax-free death benefit to eligible survivors of public safety officers whose death is the direct and proximate result of a traumatic injury sustained in the line of duty. The death benefit is not included in the decedent’s gross estate for federal estate tax purposes nor the survivor’s gross income for federal income tax purposes. The deceased must have been responding to a fire, rescue of police emergency as a member or employee of a fire or police department.
FERS Lump Sum Death Benefit (Basic Employee Death Benefit)
A surviving spouse of a deceased FERS-covered employee with at least 18 months of federal service is entitled to a special FERS death benefit called the Basic Employee Death Benefit (BEDB). The surviving spouse can take the benefit in the form of a single payment or in the form of a special annuity, payable over a three-year period.
The tax treatment of the special death benefit depends on the benefit payment option and whether a FERS survivor annuity is also paid.
If a single payment option is chosen, the tax treatment rules are:
- ∙ If a FERS survivor annuity is not paid, at least part of the special death benefit is tax-free. The tax-free part is an amount equal to the employee’s FERS contributions.
- ∙ If a FERS survivor annuity is paid, all of the special death benefit is taxable. The surviving spouse cannot allocate any of the employee’s FERS contributions to the special death benefit.
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If the surviving spouse chooses the three-year annuity option, at least part of each monthly payment is tax-free. If a FERS survivor annuity is not paid, then the tax-free part of each monthly payment is an amount equal to the employee’s total FERS contributions divided by 36 – the number of months in three years. If a FERS survivor annuity is paid, then the deceased employee’s contributions must be allocated between the three-year annuity and the survivor annuity. The allocation should be made in the same proportion that the expected return from each annuity bears to the total expected return from both annuities. The amount allocated to the three-year annuity should be divided by 36. The result is the tax-free part of each monthly payment of the three-year annuity.
CSRS or FERS Survivor Annuity
A survivor annuitant will also receive the employee’s cost contributions to the CSRS or FERS tax-free if the total cost had not been paid to the deceased annuitant at the time of death. The employee’s cost is the total contributions to the retirement plan (CSRS or FERS) that were deducted from the employee’s salary throughout the employee’s career as a federal employee. OPM will supply to the annuitant each January on Form 1099-R the gross annuity and the taxable annuity received during the previous 12 months; the annuitant’s total contributions to the CSRS or FERS; federal and state income taxes withheld; and annuitant health insurance premiums paid for all annuities. For more information about how a CSRS or FERS annuitant pays federal income tax on his or her annuity, please refer to a recent FEDZONE column entitled “How the IRS Taxes CSRS and FERS Annuities.”
The same information is not given to survivor annuitants. Survivor annuitants receive information only on the amount of their gross annuity, federal and state income taxes withheld, and health insurance premiums paid by the survivor annuitant. shown on a survivor annuitant’s CSF 1099-R. It is therefore important for survivor annuitants to be aware that a portion of their gross annuity may not be taxable – the portion that is not taxable is a return of the deceased employee/annuitant contributions to the CSRS or FERS Retirement and Disability Fund that had been previously taxed. Once the total contributions are repaid, the entire annuity is fully taxable. How much of the annuity is in fact taxable depends on several factors, including which method is used (General or the Simplified Rule) and how many survivors (spouse and children) are receiving survivor benefits.
The Simplified Method can be used if the annuity starting date is after July 1, 1986. The method must be used by surviving annuitants if the annuity starting date is after Nov. 18, 1996. Under the Simplified Methods each of the survivor annuitant’s monthly payments is made up of two parts: (1) The tax-free part that is a return of the employee’s cost, and (2) The taxable part that is the amount of each payment that is more than the part that represents the employee’s cost. The tax-free part remains the same, even if the annuity is increased due to cost-of-living allowances (COLAs).
Surviving Spouse with No Children Receiving Children Survivor Annuities
Under the Simplified Method, the surviving spouse computes the tax-free part of each full monthly annuity payment by dividing the employee’s cost by a number of months based on the surviving spouse’s age. The number will differ depending on whether the annuity starting date is on or before Nov. 18, 1996, or later. Specific instructions under the Simplified Method. The following example illustrates:
Donna, age 40, began receiving a $2,000 monthly survivor annuity in January 2021 upon the death of her husband. Donna’s husband was an active federal employee when he died. Donna received 12 monthly payments during 2021. Her husband had contributed $52,000 to the CSRS retirement fund during his federal career.
Donna must use the Simplified Method. A portion of the Simplified Rule worksheet is shown below.
Worksheet. Simplified Method for Donna’s Survivor Annuity
| 1. Enter the total annuity payments received this year. Also, add this amount to the total for Form 1040, line 16a, or Form 1040A, line 12a | $24,000 |
| 2. Enter your cost in the plan at the annuity starting date plus any death benefit exclusion. Note: If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year’s worksheet on line 4 below. Otherwise, go to line 3. | $52,000 |
| 3. Enter the appropriate number from Table 1 or 2 below. Use Table 2 if your annuity starting date is. after Nov. 18,1996 and payments are for your life and the life of your beneficiary. Otherwise use Table 1 | 410 |
| 4. Divide line 2 by line 3 5. Multiply line 4 by the number of months payments were made during 2021 (12) | $126.83 $1,522 |
Donna’s tax-free monthly survivor annuity amount is $126.83 (line 4 of the worksheet). If Donna lives to collect more than 410 payments ($126.83 times 410 payments equal $52,000), the payments after the 410th will be fully taxable.
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Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
