Are You Benefiting From Taxes Being “On Sale”?

Generally, you are told to defer taxes now because you will end up in a lower tax bracket by retirement. Modern Federal Employees with retirement savings, pensions, and concerns regarding national debt may find this advice outmoded.

We can delve further into this antiquated idea by inquiring about the following:

  • How does someone drop to a lower tax bracket?
  • How common is it for federal retirees to drop to a lower tax bracket?

You can drop to a lower income tax bracket by having less taxable income.There are two ways to lower your taxable income:

Imperfect as it may be for retirement savings, you have the easy option of taking home less overall income. The second option would be that you can invest in such a way as to generate tax-free income. This would be money that you can spend during your retirement that will not be flagged as income on your taxes by the IRS. This option is frequently overlooked but is especially crucial for employees who will be receiving forever-taxable benefits in their retirement, such as federal employees

A large number of FERS employees in the last seven years have been incorrectly told they would be seeing “retirement income tax relief”  and have not, simply because, on average, they were not qualifying for lower tax brackets in retirement because they brought home too much taxable income.

Retirement Stool of the FERS

Think about taxation of the three legs of the FERS retirement stool:

  1. FERS/LEO Pensions – Over 98% taxable as income


  1. Traditional TSP Disbursements – 100% taxable as income

– This is also applicable to Traditional 401Ks and Traditional IRAs


  1. Social Security Benefit – Often 85% is taxable as income

– Operating on the assumption that the combined total of your Traditional TSP/IRA withdrawals and  your FERS/LEO pension equals $34,000/year or more

There are three results from what we have charted this far:

  1. For most all of Federal retirees that follow the Traditional three-legged outline will be forever-taxable at whatever rate the government chooses.


  1. On average career, federal employees will have enough taxable income to stay in the same tax bracket through their retirement as they were during their working career.


  1. You will not ever be able to change or adjust the tax treatment of your social security benefits or your pension. Taking action to protect yourself from future higher tax rates will heavily depend on how you choose to invest your retirement savings.

Which leaves the question as to where taxes for your current bracket go in the future? There are a wealth of useful resources to aid you in forming your answers to this question. But with the national debt reaching $21trillion, the government was continually spending on the rise, and new tax cuts scheduled to recede in seven years, it is difficult to assume anything other than taxes rising in the next decade.

Retirement Income Tax Options

We cannot, within the confines of the law, avoid paying taxes outright, the contrast between tax-free and taxable income for retirement for Federal Employees is contingent upon when taxes are paid on savings for retirement.

Option 1: before funds are invested in growing, we can pay tax on contributions at current income-tax.

Option 2: we can pay income tax on our withdrawals (which will equal the sum of both your contributions and earnings) at whatever rate is assessed for your tax bracket in retirement (i.e., paying tax at an unknown rate on the entire “yield” later on). Many analysts predict that these rate increases are imminent. In the interest of quick assessment, let’s suppose tax rates stay the same in retirement as they are currently  and compare our options:

Option 1

    Invest $10,000 (after-tax)

    Total 2018 Tax Liability (at 22%): $2,200.00

    Balance at Retirement (hypothetical): $100,000

    Taxes owed upon withdrawal of $100,000: $0

    Balance After Tax: $100,000

    Sum of Taxes Paid: $2,200

Option 2

    Invest $10,000 (pre-tax)

    Total 2018 Tax Liability: $0 (deferred)

    Balance at Retirement (hypothetical): $100,000

    Taxes upon withdrawal of $100,000 (at 22%): $22,000

    Balance After Tax: $78,000

    Sum of Taxes Paid: $22,000

Realistically, there are a numerous aspects to think about regarding your financial professional or CPA, but if we hypothesize that it cost one thousand percent more to defer those taxes – even with the same rate – because you are not just paying your contributions, but you are paying tax on the full balance of the account..

There are not many legal strategies for generating tax-free income. Which is not at all surprising when you consider that the future of the government’s revenue heavily depends on taxation of the TRILLIONS of dollars being grown by Americans in their  retirement accounts, such as TSPs, IRAs, and 401Ks

Tax-Free Income Strategies

  1. Roth TSP/Roth 401K
  • No limited earnings
  • Annual contribution limits ($18,500/yr)
  • TSP Modernization Act = no more ‘Pro-Rata’ rule
  1. Roth IRA
  • Limited earnings apply (starting at $135,000 household income)
  • Annual Contribution limits ($5,500/yr)
  • Held for (longer of) 5 years or until 59.5
  1. Investment Grade Life Insurance
  • No earnings/contribution limits
  • Health & Lifestyle factors considered
  • Powerful additional benefits available
  1. Municipal Bonds
  • When interest rates rise, bonds lose value
  • Suppressed returns in the low-interest rate environment

This article is very much focused on how the incorporation of tax planning into the fabric of your retirement plan is of the utmost importance to everyone. However, deciding which strategies, or the combining of them, works best for you hinges on various other factors. Your dedication to voicing and acting on your concerns now makes all the difference for your future.


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