Q&A: Tax Withholding on a FERS or CSRS Pension

Q&A: Tax Withholding on a FERS or CSRS Pension

Question

Hi Stephen, I’m filling in my retirement paperwork and have a quick question about tax withholding:

  1. Federal withholding W-4P:  Do you suggest I just have usual federal tax withheld under my “single” status?
  2. State withholding:  should I elect to NOT have state income tax withheld from my annuity?  If not, what do you suggest I use for either the number of allowances or the set dollar amount?

Answer

When it comes to tax withholding, my general guidance with that is a “best guess.”  Let me answer your question about State withholding and then I’ll explain Federal.  
 
For state tax withholding, I usually measure your yearly state tax liability as a percentage of current income.  When your income goes down in retirement, the tax gets reduced proportionately.  
 
For example:
If your recent tax returns showed a tax of $10,000 on an income of $200,000, that would suggest a tax rate of 5%.
    1. Using the 5% ballpark, if your pension is going to be $40,000, 5% would be $2,000.
    2. You can divide the $2,000 by 12 = $167
Will the numbers be perfect?  No – you might be slightly higher or lower, but for the first year of retirement it’s a good guess, and we can always adjust withholdings in future years using OPM’s online portal designed for servicing annuitants – www.servicesonline.opm.gov 
 
Keep in mind:
For federal tax withholding, it’s much more nuanced and complicated for two reasons:
  • you’ll likely be in a lower tax bracket, and 
  • you will not have Social Security nor Medicare taxes withheld (you don’t pay Social Security tax nor Medicare tax on pension income).  
OPM will calculate a withholding based on your filing status (ex. “single,” “married filing jointly,” etc.) and the amount of “allowances” you claim.  The filing status is pretty straight-forward.  Whatever status you use when filing taxes, use here.  For allowances, I use the max of three, which is what OPM assumes, too.  (The more allowances you claim, the less tax is withheld.)
 
Again, the numbers won’t be perfect, but it’s usually close enough and we can adjust things going forward.
 

I hope this helps!

Stephen

If you are looking for this type of financial planning guidance on a personalized level, request a 1-on-1 meeting in the form below.

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