“I retired from PHMSA/USDOT January 2021 and I just received my first W2 form from the Department of Interior and It says that I paid money into SSA and also Medicare. I did not know that I still had to pay into Social Security after I retired. Can you please verify that this is correct and if not who I contact to fix this problem?” – Michael.
How will taxes impact your retirement?
One of the BIGGEST mistakes that Federal Employees make, is underestimating their tax liabilities in retirement.
If you think that taxes will be lower when you retire, that most likely will not be the case. Under the Federal Employee Retirement System (FERS) a significant portion of your retirement will be subject to federal income taxes in retirement.
Throughout Michael’s working years with the federal government, he paid into Social Security and Medicare. When he retired from the Department of Transportation (DOT) he was surprised to learn about taxes he would still have to pay after he retired.
To help determine the answers to Michael’s question, we have to first understand the various types of taxes that a federal employee pays.
Types of taxes withheld from your paycheck
As a federal employee, Michael received a regular paycheck during his career (well, maybe an occasional furlough was in there from time to time… but for the most part let’s just assume that Micahel was consistently paid). Federal Employees receive W-2 income.
Michael’s W-2 wages were subject to some payroll deductions like salary deferral to the TSP, Health Care and Life Insurance premiums, and federal income taxes.
Here are some deductions that are often deducted automatically from your paycheck:
- Federal Income Taxes (FIT)
- State Income Taxes
- *FERS Pension
- Federal Insurance Contributions Act (FICA)
- Social Security
- Medicare
*Your FERS Pension is NOT a tax; however, there is withholding from your paycheck for as long as you are working and paying into FERS.
FICA deductions are withheld from your gross pay; the amount withheld depends on your gross wages while you are working. You pay FICA taxes, and your employer, the federal government, also pays them on your behalf. You cannot elect not to pay FICA taxes in the United States.
The Federal Insurance Contributions Act (FICA) taxes fund social security for retirees, surviving spouses, and the disabled.
There are other payroll deductions that can occur as well, such as health insurance premiums, life insurance premiums, your contributions to the Thrift Savings Plan (TSP), and so on.
How is the FERS Pension Taxed in Retirement
When you apply for an immediate retirement from the Federal Government and separate from service, you are no longer considered an employee.
As a Retiree from Federal Service, your pension will be considered 1099-R income. The “R” represents Retirement. This is different than W-2 income but still subject to taxes.
Taxes you have to pay 1099-R
When you receive your FERS Pension as a Retiree, you still have to pay the following:
- Federal Income Taxes,
- State Income Taxes,
Withholdings as a 1099-R recipient under FERS you will not see occurring anymore as a Retiree include:
- FERS Pension withholdings,
- Federal Insurance Contributions Act (FICA)
- Social Security
- Medicare
As a Retiree under FERS you are not paying into Social Security or Medicare like you were during your working years, providing that you do not have additional income from employment, like a job after retirement.
Medicare and Taxes
Under the Federal Insurance Contributions Act (FICA), a portion of your FICA taxes went to paying into Part A of Medicare. At age 65, you are eligible for Medicare. Even though you may have Federal Employee Health Benefits, you must still enroll in Medicare.
Medicare is broken down into several parts.
Part A (Hospital Insurance): Helps cover inpatient care in hospitals, skilled nursing facility care, hospice care, and home health care.
Part B (Medical Insurance): Helps cover things like:
- Services from doctors and other healthcare providers
- Outpatient care
- Home health care
- Durable medical equipment (like wheelchairs, walkers, hospital beds, and other equipment)
- Many preventive services (like screenings, shots or vaccines, and yearly “Wellness” visits)
Part D (Drug coverage): Helps cover the cost of prescription drugs (including many recommended shots or vaccines).
Most Medicare recipients do not have to pay for Medicare Part A when they retire. The reason is that they already paid for Medicare Part A with their FICA withholdings during their working years.
However, you do not pay into Medicare Part B or Medicare Part D during your working years. Therefore, when you retire from Federal Service as a Retiree, you may have to purchase Part B and D contingent on your needs. We call these “quasi-optional” You do not have to have them, but you probably have to have them.
In Michael’s case…
You will receive a W-2 which reports your taxable income and withholdings the year that you retire for any time you earned a wage while being employed by the government.
The year that most federal employees retire, they receive two reportable forms of income: W-2 and a 1099-R.
This can be especially “tricky” if you retire in December of one year because your pay isn’t made until January of the following year.