Retirement isn't just about reaching your pension eligibility — it's about maximizing how much of your hard-earned money you actually get to keep. This module walks you through how your various federal retirement income streams are taxed, how to strategically sequence your withdrawals, and how to avoid common pitfalls like Medicare penalties and surprise tax bills.

How Your Federal Retirement Income is Taxed

Not all retirement income is created equal in the eyes of the IRS. Understanding the tax treatment of each income source is the first step to building a tax-efficient plan.

Income Source	Federally Taxable?	Key Notes
FERS Pension	✅ Yes	Taxed as ordinary income. A small portion representing your post-tax contributions is returned tax-free over your lifetime.
FERS Supplement (RAS) ? Retirement Annuity Supplement - bridges the gap until Social Security	✅ Yes	Taxed as ordinary income.
Traditional TSP Withdrawals	✅ Yes	Contributions are tax-deferred, so all withdrawals (contributions and earnings) are taxed as ordinary income.
Roth TSP Withdrawals	❌ No	Qualified distributions (age 59½+ and account held 5+ years) are completely tax-free.
Social Security	⚠️ Maybe	Up to 85% is taxable if your "provisional income" exceeds certain thresholds.[SSA]
VA Disability	❌ No	This is a non-taxable benefit at the federal and state level.

🚨 The IRMAA Trap: Medicare's Stealth Tax

One of the biggest financial shocks for new retirees is the Income-Related Monthly Adjustment Amount (IRMAA) ? Medicare premium surcharge based on income . If your Modified Adjusted Gross Income (MAGI) ? Your AGI plus tax-exempt interest and foreign income from two years prior exceeds certain thresholds, you will pay a significant surcharge on your Medicare Part B and Part D premiums.^{[Medicare.gov]}

What counts towards MAGI? Your FERS Pension, Traditional TSP withdrawals, Social Security benefits, and most other forms of income. What does NOT count? Roth TSP withdrawals.

🔁 Strategic Withdrawals: The Three-Bucket Approach

Smart income planning involves thinking of your assets in three distinct "buckets" and deciding which to draw from based on your tax goals for the year.

The Strategy: In a year where you have high expenses, you might pull from your tax-free Roth TSP to avoid increasing your taxable income and triggering IRMAA. In a lower-income year, you might pull more from your Traditional TSP to "fill up" lower tax brackets, effectively getting the money out at a lower tax rate than you might face later when RMDs ? Required Minimum Distributions starting at age 73 begin.

🧠 A Sample Withdrawal Game Plan

Let's look at a hypothetical SCE retiree who separates at age 57 with a pension, supplement, and both Traditional and Roth TSP balances.

• Phase 1 (Age 57-62): The "Gap" Years

  Live primarily on the FERS pension and tax-free FERS supplement. This is the ideal window for strategic, low-tax-bracket Roth conversions from your Traditional TSP.

• Phase 2 (Age 62-72): The "Bridge" Years

  The supplement ends. Decide whether to start Social Security or delay it. Begin drawing from your TSP accounts. Pull from Traditional TSP to fill up the 12% and 22% tax brackets, then switch to Roth TSP for any additional income needs to stay below IRMAA thresholds.

• Phase 3 (Age 73+): The RMD Years

  Required Minimum Distributions (RMDs) begin from your Traditional TSP.^[IRS] Your withdrawal strategy is now less flexible. Your RMD, pension, and Social Security will create your taxable income baseline. Use your Roth TSP for large, lumpy expenses to avoid pushing your income even higher.

State Tax Considerations

Federal taxes are just part of the picture. State taxes can significantly impact your retirement income, and many federal retirees relocate to more tax-friendly states. Here's what you need to know:

Tax-Efficient Strategies Throughout Retirement

Qualified Charitable Distributions (QCDs) ? Direct transfers from IRA to charity, up to $100k/year

Once you reach age 70½, you can make direct transfers from your IRA to qualified charities. These distributions count toward your RMD but don't increase your taxable income — a win-win for charitable givers.

Health Savings Accounts (HSAs) as Retirement Tools

If you have an HSA-eligible health plan, consider maxing out HSA contributions. Unlike FSAs, HSAs roll over year to year and offer triple tax benefits: deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses.

Managing the Annual Leave Lump Sum

Your annual leave payout at retirement is fully taxable in the year received. Consider:

• Timing retirement early in the year to spread income across two tax years
• Increasing TSP contributions in your final year to offset the tax hit
• Planning for estimated tax payments if withholding isn't sufficient

Common Tax Mistakes to Avoid

🔎 Official Sources & Tools

• IRS Publication 721: Tax Guide to U.S. Civil Service Retirement Benefits
• TSP Publication: Tax Rules about TSP Payments
• Social Security Administration: Income Taxes And Your Social Security Benefit
• Medicare.gov: Costs for Part B
• IRS: Required Minimum Distribution FAQs

Next in Your Journey

Now that you understand the tax implications of your retirement income, it's time to see how all the pieces fit together.

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Putting It All Together →

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