Military retirement pay is considered taxable income by the IRS unless you retired because of a disability. Like civilians, federal tax is withheld from each check or direct deposit. Also like civilians, the amount withheld depends on what you earn and the number of dependent exemptions you claimed on your Form W-4.
Military retirement pay may be taxed in specific situations. For example, 20 states do not tax military retirement at all, while 13 states only implement partial taxation. 42 states provide various forms of exemptions for military personnel in order to help offset tax responsibilities as thanks for service to the country.
How the Process Works
Instead of receiving a W-2 from an employer in January of each year, military retirees receive a Form 1099-R from the Defense Finance and Accounting Service in Cleveland. The 1099-R lists the total of your taxable retirement pay and the amount of federal tax that was withheld for the past calendar year.
The withheld taxes have already been sent to the IRS. When it comes time to file your return, what you paid during the past year is credited to what you owe for that year. If you paid too much, you’ll get a refund. If you paid too little, you have to make up the difference.
Tax Exclusions for Disability Retirement
Military disability retirement pay, not to be confused with Department of Veterans Affairs benefits, may be partially taxable or not taxable at all. Military disability retirement pay is compensation for retirement that was due to an illness or injury resulting from active service. Specific criteria such as how and under what circumstances you became ill or were injured apply.
Fortunately, resources are available to help you sort out whether your military disability retirement pay qualifies for a full or partial federal tax exemption. You can start by contacting your local VA office. Information and free advocacy is also available through some Veterans of Foreign Wars or American Legion posts. If it’s determined that your military disability retirement income is tax exempt, you will not receive a 1099-R and you do not need to report this income when you file your taxes.
Veterans Affairs Benefits
If you have an illness or injury that was the result of active military service you may also be entitled to VA benefits. It used to be that veterans could not receive military retirement pay and VA benefits. They had to choose one or the other. However, since 2004, military retirees with a 50 percent or higher disability rating can collect both through what's called Concurrent Retirement Disability Pay. Criteria in addition to the 50 percent or higher disability rating apply, and tax rules may be different if you’re collecting this type of pay. Be sure to check with the VA and a tax professional.
State Taxes Vary
State taxes are a different story. Twenty states do not tax military retirement income at all. An additional 13 states have partial exemptions. For example, Colorado excludes up to $24,000 of military retirement pay depending on your age. Another nine states don’t tax personal income of any kind, military or civilian.
With 42 states offering exemptions or partial exemptions, chances are you live in one of them. The eight states that do tax military retirement pay are California, Montana, New Mexico, North Dakota, Rhode Island, Utah, Vermont and Virginia. Since tax codes vary from state to state and can change from year to year, it’s a good idea to consult with a tax professional before you start packing to move to a non-taxing state.
Social Security and Military Retirement
Regardless of where you live, military retirement pay is not considered earned income by the Social Security Administration. So the chunk taken out of civilians’ paychecks for Social Security (it’s usually listed on your pay stub as FICA – Federal Insurance Contributions Act) is not withheld from military retirement pay.
When it comes time to collect Social Security retirement benefits, your military retirement pay will not be affected. Whether you decide to start collecting partial Social Security retirement benefits at 62, or wait until you reach your full retirement age, you’ll receive the full amount you’re entitled to based on what you earned over the years.
Additionally, the SSA does not consider military retirement pay to be “earned income.” So you can still earn money from a job while collecting military retirement pay and Social Security benefits. However, there are limits to what you can earn. The limits change from time to time and are different if you start collecting Social Security benefits at 62 instead of waiting until your full retirement age. Be sure to check the SSA’s website for current earning limits.
- Social Security Administration: Military Service and Social Security
- Military.com: Taxes on Disability and Retirement Pensions
- Military.com: Retired Pay Tax Withholding
- Military.com: Taxable Income From Retired Pay
- Military Benefits.info: States that Do & Don’t Tax Military Retirement Pay
- Hill & Poyton: Double Bonus – Military Retirees Can Receive Retirement and VA Pay
LeDona Withaar has over 20 years’ experience as a securities industry professional and finance manager. She was an auditor for the National Association of Securities Dealers, a compliance manager for UNX, Inc. and a securities compliance specialist at Capital Group. She has an MBA from Simmons College in Boston, Massachusetts and a BA from Mills College in Oakland, California. She has done volunteer work in corporate development for nonprofit organizations such as the Boston Symphony Orchestra. She currently owns and operates her own small business in addition to writing for business and financial publications such as Budgeting the Nest, Zacks and PocketSense.