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How is your military pension taxed?


One benefit of joining the military is the pension you will receive after 20 years. How is it taxed?
One benefit of joining the military is the pension you will receive after 20 years. How is it taxed?
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When you choose a life of service with the United States armed forces, you make a lot of sacrifices. One of the benefits, however, is your military pension, which you receive upon retirement after active duty beyond 20 years. This means if you joined the Armed Forces at 20, you could potentially retire around age 41.

Of course, there are going to be tax concerns, but if retirement is looming on the horizon, we can help you get informed about your options. The size of your pension depends on your pay grade, but it lasts a lifetime. If you retire after 20 years, your pension is a percentage of your basic pay. But if you remain in the military for 40 years, your pension is 100 percent of your basic pay. Additionally, military pensions increase each year to adjust for cost of living.

There are three different programs of retirement [source: Military.com]:

  1. Final Pay calculates benefits based on your last month of pay (for those who entered service before September 1980)
  2. High 36 calculates benefits based on the highest level of pay during your last 36 months of service (for those who entered service between Sept. 8, 1980 and August 1986)
  3. CSB/REDUX is optional, and offers a $30,000 bonus after 15 years of service in exchange for a reduction in lifetime benefits. People who entered service after August 1986 may choose between High 36 and REDUX.

Regardless of which plan you choose, pensions are taxable because the government views them as income. The Defense Finance and Accounting Service deducts the appropriate federal taxable amount (depending on your pay grade and how much you receive) and withholds it, then sends you a tax form in January showing your paid pension and how much tax was withheld [source: Military.com].

On the state level, however, taxes on military pensions differ depending on where you live. Some don't tax military pensions at all, while some exempt the first few thousand dollars from taxation. For example, Hawaii doesn't tax military retirement pay, but West Virginia waives up to $2,000 of taxes for military retirees. Some offer a low-income exemption, and others tax your pension according to federal tax rules [source: Birk].

Many military retirees also have questions regarding exemptions and deductions. Here's a list of the more common ones [source: Defense Finance and Accounting Service]:

  • Survivor Benefit Plan: This plan is deductible from taxes.
  • Retired Serviceman's Family Protection Plan: Also deductible from taxes.
  • Debt Deductions: If you pay back any overpayments or premium adjustments, these are deductible.
  • Disability: If you retire under a disability law, your entire pension is non-taxable as long as you meet certain conditions.
  • VA Compensation Deduction: If you retire under non-disability, your taxable income is reduced by the amount of any VA compensation you receive.
  • Combat-Related Special Compensation: This compensation is non-taxable.

Also excluded from federal taxable income are veteran's benefits. Examples of veteran's benefits include: disability compensation, grants for accessible homes or vehicles if the veteran was disabled in the line of service, and insurance proceeds or dividends.

Now that you've gotten a glimpse at the many pension programs, tax exemptions and deductions available to you as a service member, it's paramount you work with a military tax expert to ensure you make the right decisions for you and your family.

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