2007 Tax Guide to Your Federal Pension

Summary of Tax Treatment of Pensions and Annuities

Income tax liability - If you are retired from the federal government, or if you are the survivor or beneficiary of a federal employee or retiree who died, you must pay federal income tax on your benefits except for  the portion attributable to the mandatory contributions you made to your retirement system. 

Gross income requirements - If annual gross income is less than a certain amount you may not have to file a federal income tax return for that year.  The gross income filing requirements are in the instructions for Form 1040, 1040A and 1040EZ.

Withholding taxes - Your annuity is subject to federal income tax withholding, unless you choose not to have taxes withheld.  If you choose not to have tax withheld, or if you do not have enough tax withheld, you may have to make estimated tax payments.  You may also owe a penalty if your withholdings and estimated tax payments do not cover most of the tax shown on your return. 

1099-R - Federal annuitants will receive a 1099-R by mail every year, normally by January 31.   This document contains information on the total amount of annuity payments that you received during the preceding tax year and the amount that was withheld for taxes. 

After January 31, Foreign Service annuitants can obtain a copy of their 1099-R through www.EmployeeExpress.gov.  Civil Service annuitants can obtain a copy of their 1099-R through OPM's website at https://www.servicesonline.opm.gov/.  Annuitants will need personal identification numbers issued by OPM to access information on their annuities.

Tax-free portion - To calculate the tax-free portion of either your Foreign Service or Civil Service annuity, you can use the worksheet included in IRS Form 1040 or 1040A or the worksheet in IRS publication #721, Tax Guide to US Civil Service Retirement Benefits. 

Alternatively, there is a tax-free annuity calculator on the Office of Personnel Management website http://apps.opm.gov/tax_calc/index.cfm.  You may use the OPM calculator to calculate the tax-free portion of either Foreign Service or Civil Service annuities.   

FS Disability retirement - Employees who joined the Foreign Service prior to September 25, 1975 and who retire on disability are not subject to Federal income tax.  Employees who joined after that date are subject to the same taxation rules as other annuitants. 

Lump sum payments - A lump sum payment for unused annual leave is treated as a salary payment.  It is taxable as wages in the tax year during which you receive it.  Withholdings will be deducted from your lump sum payment.

Refunds - If you leave federal service and are not eligible for an immediate annuity you can choose to receive a refund of the money in your retirement account.  The refund will include both regular and voluntary contributions, plus interest.  The portion of the refund that consists of contributions is not taxable, but interest is taxable.

Voluntary contributions - Voluntary contributions to the retirement fund are those made in addition to the regular contributions that were deducted from your salary.  They also include the regular contributions withheld from your salary after you have the years of service necessary for the maximum annuity allowed by law. 

Interest on contributions - A refund of voluntary contributions is taxable in the tax year it is distributed unless you roll it over to a traditional IRA or another qualified retirement plan.  Voluntary contributions are not the same as employee contributions to the Thrift Savings Plan. 

Thrift Savings Plan - All of the money in your Thrift Savings Plan (TSP) account is taxed as ordinary income when you withdraw it. This is because neither the contributions to your TSP account nor its earnings have been included in your taxable income previously.  The way you choose to withdraw your account balance determines when you must pay income taxes on your withdrawals.

Recovery of the Tax-free Portion of Your Pension

The following information is excerpted from IRS publication #721, Tax Guide to US Civil Service Retirement Benefits, Part II.  It applies to Foreign Service retirees on non-disability pensions as well as Civil Service retirees.

Your monthly annuity payment contains an amount on which you have previously paid income tax.  This amount represents part of your contributions to the retirement plan.  Even though you did not receive the money that you contributed to your plan, it was included in your gross income for federal income tax purposes in the years it was taken out of your pay.  The cost of your annuity is the total of your contributions to your retirement plan.

If you repaid contributions that you had withdrawn from the retirement plan earlier, or if you paid into the plan to receive full credit for service not subject to retirement deductions, the entire repayment, including any interest, is part of your cost.  You cannot claim an interest deduction for any interest payments.  You cannot treat these payments as voluntary contributions; they are considered regular employee contributions.

How you figure the tax-free recovery of the cost of your annuity depends
on your annuity start date.  Your annuity start date is the commencing date on your annuity statement from the Department of State for Foreign Service retirees and the Office of Personnel Management for Civil Service retirees.  If something delays payment of your annuity, such as late application for retirement, it does not affect the date your annuity begins to accrue, or your annuity start date.

If your annuity started after November 18, 1996 you must use the Simplified Method of recovering the cost of your contributions tax free. Each monthly annuity payment is made up of two parts, the tax-free part that represents your cost, and the taxable part.  The taxable part is the amount of each monthly payment that is more than your cost.  The tax-free part is a fixed dollar amount.  It remains the same, even if your annuity increases. 

Under the Simplified Method, you figure the tax free part of each full monthly payment by dividing your cost by a factor based on your age.  If your annuity includes a survivor benefit for your spouse, this number is based on your combined ages. 

To calculate the tax-free portion of your annuity, you can use the worksheet included in Form 1040 or Form 1040A or in IRS publication #721, Tax Guide to US Civil Service Retirement Benefits. 

There is a tax-free annuity calculator on the website of the Office of Personnel Management at  http://apps.opm.gov/tax_calc/index.cfm that can be used to calculate the tax-free portion of either Foreign Service or Civil Service annuities. 

The Retirement Accounts Division will mail new Foreign Service retirees a retirement contribution letter by mail not later than January 31 of the year following their retirement.  Annuitants should retain this important document in their personal records because the entire amount of contributions earned over the span of one's career will not be recovered in a single tax-year.  If you do not receive a letter from the Retirement Accounts Division with the amount of your mandatory contributions by February 15 of the year following your retirement, you should contact the Retirement Accounts Division at RAD2@state.gov.

If you have further questions on the amount of your mandatory contributions to one of the Foreign Service retirement plans, please contact the Retirement Accounts Division at RAD2@state.gov or call the Payroll Customer Support Center toll-free on 1-800-521-2553, Monday through Friday, 8:30am to 4:30pm.