Tax Strategies for Public Employees in Retirement

Public employees, including teachers, government workers, and first responders, often have unique financial situations when they retire. Many rely on pensions, 403(b) or 457 retirement plans, and Social Security, which require careful tax planning to maximize retirement income and minimize tax burdens. This blog post outlines essential tax strategies for public employees to consider in retirement.

1. Understand How Your Pension is Taxed

Most government pensions, such as those from the Teacher Retirement System (TRS) or Federal Employees Retirement System (FERS), are fully taxable at the federal level, as contributions were made pre-tax. However, state tax treatment varies:

• Some states do not tax pensions at all (e.g., Florida, Texas, Nevada).
• Others offer partial exemptions (e.g., New York, Pennsylvania).
• A few states fully tax pension income (e.g., California, Connecticut).

Before retiring, check your state’s tax laws to determine whether moving to a tax-friendly state could reduce your tax liability.

2. Optimize Social Security Benefits

• Delay claiming Social Security until full retirement age (or later) to maximize your monthly benefit.
• Consider spousal benefits if eligible.
• Use a Roth conversion strategy (discussed below) to lower taxable income in years before claiming Social Security.

3. Utilize Roth Conversions to Manage Tax Brackets

A Roth conversion allows you to move funds from a tax-deferred 403(b), 457, or traditional IRA into a Roth IRA. The converted amount is taxable in the year of conversion, but future withdrawals are tax-free. This strategy works best if:

• You retire before Required Minimum Distributions (RMDs) begin at age 73 or 75.
• You expect to be in a higher tax bracket later due to pension and Social Security income.
• You have cash available to pay the taxes on the conversion.

By spreading conversions over multiple years, you can stay within a lower tax bracket while reducing future RMDs.

4. Minimize Taxes on 403(b) and 457 Withdrawals

Withdrawals from tax-deferred retirement accounts are taxed as ordinary income. Strategies to minimize taxes include:

• Withdrawing strategically: Take distributions only as needed to avoid pushing yourself into a higher tax bracket.
• Rolling a 457 plan into a 403(b) or IRA: While 457 plans allow penalty-free withdrawals at any age after separation from service, rolling them into a 403(b) or IRA may provide better investment options.
• Taking advantage of the Standard Deduction: If your taxable income is low in a given year, withdraw just enough to take full advantage of your standard deduction.

5. Plan for Required Minimum Distributions (RMDs)

Once you reach age 73 or 75, you must start taking RMDs from tax-deferred accounts like 403(b), 457, or IRAs. Strategies to manage RMDs include:

• Roth conversions before RMD age to reduce taxable withdrawals later.
• Qualified Charitable Distributions (QCDs): If you donate to charity, use QCDs from your IRA to satisfy RMD requirements while avoiding taxable income.

6. Consider a Tax-Friendly Withdrawal Strategy

A structured withdrawal plan can help minimize taxes in retirement. Consider this order of withdrawals:

1. Taxable brokerage accounts (to take advantage of lower capital gains tax rates).
2. Tax-deferred accounts (403(b), 457, IRAs) – up to the standard deduction or lowest tax bracket.
3. Roth accounts (leave untouched as long as possible for tax-free growth).

7. Watch Out for Medicare IRMAA Surcharges

Higher-income retirees may pay extra for Medicare due to the Income-Related Monthly Adjustment Amount (IRMAA). To avoid IRMAA:

• Keep taxable income under key thresholds when taking withdrawals.
• Use Roth conversions strategically before Medicare begins at age 65.
• Consider tax-free sources of income, such as municipal bonds or a Roth IRA.

8. Take Advantage of State-Specific Tax Benefits

Some states offer tax benefits specifically for retirees:

• No state income tax states: Florida, Texas, Nevada, Washington.
• States with pension exemptions: Illinois, Pennsylvania, Hawaii (do not tax pensions at all).
• Tax credits for retirees: Some states offer tax credits for seniors based on income level.

Check your state’s tax rules and consider relocating if it provides significant tax savings.

Final Thoughts

Tax planning is a crucial part of retirement for public employees. By proactively managing pensions, Social Security, withdrawals, and tax-efficient strategies like Roth conversions, retirees can keep more of their hard-earned money. Working with a financial professional can help create a customized tax strategy that aligns with your retirement goals.

Need personalized retirement tax planning? Contact us today to create a tax-efficient strategy that fits your financial future!

*This information comes from sources we believe to be accurate. However, it is not intended as tax or legal advice and should not be used to avoid federal tax penalties. We encourage individuals to consult their own tax or legal advisors for guidance. Those involved in estate planning should work with a team that includes their personal legal or tax counsel. The information provided, including any opinions expressed, does not represent a specific investment recommendation or advice on buying or selling securities. Additionally, asset allocation and diversification do not guarantee profits or protect against losses in a declining market.