Most federal service employees select their retirement date based on a few factors, including FERS/CSRS pension payouts or Social Security timing.
However, this approach may not fully consider the potential tax implications of these decisions.
To avoid unpleasant and costly surprises, retirement planning should move beyond pension payouts and examine the tax implications of financial decisions.
Terminology Teachings
There are two issues to understand as you consider various retirement approaches.
Partial Year Income Effect
The partial-year income effect kicks in if you retire partway through a full calendar year. In this situation, you earn only part of your annual salary, which may place you in a lower tax bracket or reduce overall taxable income.
This could result in lower taxable income, depending on other income sources received during the year. But pension payments, Thrift Savings Plan (TSP) withdrawals, and Social Security benefits could increase that taxable income.
Lump Sum Payment
When you retire, all your unused and accrued annual leave is paid out in cash.
This is a nice benefit. It’s also taxed as ordinary income, which could mean higher taxes.
Real-World Hypotheticals
Another consideration is that shifting that retirement date by even a few weeks can impact taxable income. Let’s take a look.
- Susan: Late December. Susan retires on December 31. In addition to her annual salary, she receives a lump-sum payment of $20,000. Her taxable income for the year totals $160,000.
- Mike: Late January. Assuming Mike has substantially less unused leave available for payout, when he retires on January 31, he receives approximately $11,000 for a full month of work ($140,000 ÷ 12), along with a $2,000 lump sum. This gives him taxable income of approximately $13,000. Furthermore, if Mike is strategic with his pension investments, tax strategies, and TSP withdrawals, he could end up paying less in taxes than his friend Susan.
The above doesn’t account for issues such as cost-of-living adjustments (COLAs) or FERS annuity commencement dates, which often differ from separation dates. However, the examples illustrate how a difference of only a few weeks can affect taxable income and retirement-related tax planning.
**The hypothetical examples are not intended to reflect any actual outcome. Individual circumstances will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Please consult with your financial advisor.
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Determining the Right Retirement Date
Because tax burdens can vary depending on your separation date, consider the following when planning your retirement strategy.
Start Early
Consider thinking about that deadline date at least three years before leaving. Waiting until six months or so may not give you enough time to plan how your timing impacts income, taxes, payouts, and benefits.
Evaluate Multiple Retirement Dates and Their Scenarios
Each deadline decision generates different tax outcomes, meaning not all separation dates are optimal. Take the time to run income and tax scenarios for the dates you’re thinking about.
These dates may provide favorable retirement timing opportunities based on federal retirement benefit rules:
- 2026: Saturday, October 31
- 2027: Saturday, October 30
- 2028: Saturday, April 29 & Saturday, Sept. 30
- 2029: Saturday, March 31, and Saturday, September 29
- 2030: Saturday, Aug. 31, and Saturday, March 30
Develop an Income Estimate
Salary, lump-sum payouts, and pension income are essential when eyeing a retirement date. So are Social Security benefits, capital gains, and income from IRAs or stock investments.
Team Up with Professionals
Consult with CERTIFIED FINANCIAL PLANNERS© who understand federal pensions and benefits. The Fed-focused CFPs© at Serving Those Who Serve have extensive knowledge of federal employee benefits, including FERS and CSRS pensions, TSP rules, and retirement strategy planning.
Thinking Through Your Federal Employee Retirement Timing Strategy
Tax consequences are essential when targeting your retirement date. Not considering taxes on retirement benefits, withdrawals, or payments can generate unwelcome tax surprises.
Depending on the CFPs© at Serving Those Who Serve can help build the big picture of your current and retirement income, including potential tax consequences. These experts can help reduce costly surprises and ensure that you have enough resources to enjoy your post-retirement life.
To set up a no-obligation appointment, email [email protected] or visit the website.
The information has been obtained from sources considered reliable but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Serving Those Who Serve writers and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy suggested. Every investor’s situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making any investment or financial decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. 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. **
