How To Minimize Federal Tax On Retirement Pension [Avoid Mistakes]

By Sam •  Updated: 05/12/21 

Do you have a plan to minimize federal taxes in retirement?

Do you know how your pension will be taxed and how your pension will affect your ability to collect social security?

We all know that we will need to pay for housing, food, and medical care after we retire. But how can we know what our tax liability will be before we retire?

Furthermore, did you know the money choices you make today will affect how much tax you will pay in retirement. (Depending on your strategy you may be able to pay *no taxes* in retirement).

In this post, I’ll walk you through how federal taxes are calculated on pensions in retirement. I’ll also help you understand how pensions affect social security and moves you can take today to minimize the tax you will pay in retirement.

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Table of Contents

Note: As always, this is a personal blog and does not represent an official position of the federal government. Please do not mistake my blog for financial or tax advice.

Note- Since this is a technical topic, I had a nice chat with financial planner  Brian Sigwart to make sure I didn’t miss anything. Brian is a certified financial planner with Cummins and Associates Financial Group. He focuses his practice on educating federal employees how their benefits work. If you want to speak to a certified financial planner who knows federal employee benefits, you can contact him here.

Are pensions subject to federal tax in retirement?

The short answer is yes. You will be taxed on your FERS pension in retirement by the federal government. FERS annuities are taxed as ordinary income. Therefore, the amount of tax you will pay will depend on whether you are married and your income in retirement.

Unsure of how much of your pension will be taxed? Here is the IRS website with the marginal tax brackets. (Note these just indicate how much your “last dollar” is taxed. The total amount of tax you pay as a percentage of your income will be much lower than the marginal rates).

Your state may or may not tax your pension. Some states do not tax any income and other states have special rules where they do not tax pension income for retirees.

Federal Employee Retirement System FERS

How do pensions affect social security?

If you are a FERS employee, you are eligible for social security. You can collect both a FERS pension and social security. However, your FERS pension will affect how much of your social security benefit is taxable. (Still confused? Check out this post I wrote on how federal retirement works.)

Pensions and “provisional income”

To understand how your pension will affect your social security income, we first need to describe a concept called “provisional income”.

When you’re earning income, it’s pretty straightforward to calculate your taxable income. In general, you pay income taxes on all of your salary, except for certain payroll deductions that are taken out pre-tax (namely traditional TSP/401(k)/457(b) contributions, and health insurance).

When you’re earning income, it’s pretty straightforward to calculate your taxable income.

In contrast, when you retire, you can expect to pay income tax on your pension, withdrawals from tax deferred accounts (like your traditional TSP or a traditional IRA), and you may or may not pay taxes on social security.

The government decides whether (and how much) tax you pay on social security by calculating your provisional income.

What is provisional income?

When you begin to claim social security, you will need to calculate your provisional income each year. Your provisional income is calculated by adding together

The short answer is that provisional income is all of your non-social security income plus half of your social security income.

Brian also wanted me to point out that provisional income includes “non-retirement annuity contract gains upon withdrawal” but does not include distributions from Non-MEC life insurance. If either of these apply to you, you may want to work with a tax professional or financial advisor to come up with a financial plan.

If all of this is too confusing for you, the short answer is that provisional income is all of your non-social security income plus half of your social security income.

Provisional income and social security

Why is provisional income important? Provisional income determines whether and how much your social security benefits are taxed.

Shockingly, the Social Security Administration reports that more than 40% of Americans do not pay taxes on any of their social security income. In other words, many retired American couples make less than $32,000 per year (or $16,000 per person). While there are tax tricks you can do to minimize your provision income, I believe that many people in this group are living nearly entirely on their social security benefits. However, as a federal employee, even if you never saved anything else for retirement, you’d be better off than these Americans because you could access both your FERS pension and social security.

Can you pay 0 federal taxes in retirement with a pension?

Brian mentioned that he strongly recommends the book The Power of Zero, which is a guide to paying no federal taxes in retirement (that’s an affiliate link). In fact, Brian told me that he is able to help most of his non-federal clients pay no tax in retirement.

You can pay no taxes in retirement by minimizing your retirement income. For example, if you had all of your assets in Roth IRAs and the Roth TSP, your withdraws would be tax free. Furthermore, if you are able to keep your total tax/dividends/capital gains below $12,000 per year, you would be in the 0% tax bracket and your social security would be tax free.

If you are able to keep your total tax/dividends/capital gains below $12,000 per year, you would be in the 0% tax bracket and your social security would be tax free.

Obviously, keeping your income below the 0% marginal tax bracket is nearly impossible for a federal employee retiring after 30 years. In fact, for most people, your FERS pension will force you into paying taxes on 85% of your social security benefits. (Note that I like to think of it as getting 15% of social security tax free. I’m a glass half-full person).

How to minimize federal taxes in retirement with a pension?

You can minimize federal taxes in retirement on your FERS pension by contributing as much money to Roth accounts as possible. Unfortunately, you cannot do much more than that.

So- should you contribute to your Roth TSP? I compared the Roth and Traditional TSP in an earlier post. I believe that for most people it is a toss-up.

However, I want you to know that Brian and I disagree about the importance of Roth contributions. So I thought I should lay out both of our arguments so you can make your own decision.

Why you should contribute to Roth accounts

Brian believes that you would be foolish not to contribute to Roth accounts. He believes that income taxes will certainly go up in the future. Brian stated the following reasons for his belief.

Brian concludes that income taxes must go up in the future. Therefore, even if the government taxes you at a high marginal rate now, you should pay the tax now. If you use a Roth account, you will protect yourself from future tax increases.

Will income taxes go up?

I don’t disagree with Brian’s goal of tax minimization. Furthermore, I agree with his facts about debt and taxes. However, I won’t bet my whole retirement strategy on the fear of a tax increase.


I believe that tax increases on the middle class are unlikely in the future.

  1. Firstly, modern monetary theory states that national debt does not matter. While that sounds shocking, the bond market shows no worries about our current borrowing pattern. And economists no longer believe inflation depends upon the money supply. We can literally print money to pay for the debt without causing inflation.
  2. Congress must pass tax increases. Who wants to raise taxes on retirees? Republicans oppose raising taxes on anyone. Democrats oppose taxing the middle and lower classes. Therefore, nobody wants to raise income taxes on retirees.
  3. If we do need to raise taxes to pay off our debt, there are other ways to raise taxes.
    1. The US may institute a Value Added Tax (VAT) like Europe.
    2. Or the US may enact a wealth tax.
    3. Finally, we might do something really crazy like taxing Roth withdrawals or abolishing Roth accounts.

Do I really think Congress will tax Roth withdrawals in the future? Of course not. But you would be kidding yourself if you thought Congress does not have the power to tax these withdrawals.

In short, we don’t know what will happen in the future. While Brian is convinced the US will raise income taxes on retirees in the future, I am less certain of this fact.

I cannot emphasize enough that I have presented what Brian and I *think* will happen in the future. The reality is that no one knows what taxes Congress will enact in the future. I recommend that you come up with your own strategy for retirement.

Should you focus on minimizing federal tax on your pension in retirement?

Thus far, I stated that you will need to pay (federal) tax on your FERS pension in retirement. I also talked about how your FERS pension affects social security. Finally, I presented some thoughts about minimizing your federal taxes through maximizing Roth contributions.

However, we should examine whether minimizing federal tax on your pension in retirement should be your primary goal. Despite what the internet tells you, I don’t your primary goal should be tax minimization. Instead, I believe that you should focus on maximizing your post-tax income/wealth.

Your primary goal should not be tax minimization. Instead, focus on maximizing your post-tax income/wealth.

You might wonder how these two goals differ. In many cases, minimizing taxes results in maximizing your income. However, you may choose a tax efficient strategy that results in your having less wealth.

Before the increase in the standard tax deduction, I knew people that held a mortgage solely “for the tax deduction”. Because they don’t pay tax on the mortgage interest, they lower their taxes. (BUT- they’re paying interest. As a result they would be better off paying off the house and paying more taxes).

Summary- Death, taxes, and my retirement plan

In this post I tried to explain what rules apply to federal taxes on your pension in retirement. I provided a general overview of some thoughts you might want to consider. However, only you can know your own best strategy.

In summary, I believe you should not be afraid of paying taxes. On the other hand, I think you should work to minimize taxes by using retirement accounts whenever possible. Both Roth and Traditional accounts present amazing tax benefits; the distinction between the two comes down to what you think will happen in the future.

I personally don’t believe there is a clear cut winner between Roth & Traditional accounts. We have money in both types of accounts and plan to contribute to both for the foreseeable future.

If my wife or I retire early, we can do Roth conversions during the years when our income is low. However, if we both continue to work, contributing predominantly to our traditional accounts helps us minimize our taxes during our high income years. (Including the 50% marginal tax cliff created by the American Rescue Plan).

What do you think? Am I totally wrong? Do you love it? Let me know on social media and hit the subscribe button!

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Sam i.e. "Gov Worker" started working for the government at age 18 and loved it so much that he never left. He started GovernmentWorkerFI in 2019 to help fellow federal employees understand their benefits, take control of their finances, and live their best lives.

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