Is a Military Pension Taxable? Federal Rules and State Checks (a Walkthrough from Savant Wealth Management)

Is a military pension taxable federally?

Yes. Federally, military retired pay is gross income taxed at ordinary rates, and DFAS reports it on a Form 1099-R. People say "my pension is tax-free in my state," and that can be true for the state return. It says nothing about the federal one. Retired pay isn't wages, so it carries no Social Security or Medicare tax.

The second paraphrase is "disability retirement is tax-free." That holds only in limited cases: Chapter 61 retired pay tied to a combat-related injury, pay for service before September 25, 1975, or the part equal to VA compensation you could receive. CRSC is tax-free. CRDP is taxable. Another page covers both in depth.

Your rating and your years decide which picture applies. Rated under 50%, or with fewer than 20 years: VA pay replaces an equal amount of retired pay (the VA waiver), so your total stays the same and only the tax drops. Rated 50% or more with 20 years: CRDP restores the retired pay, which stays taxable, and VA pay comes on top tax-free.

Option 1: keep the full retired pay

This option fits a retiree with no condition from service. Every dollar of retired pay stays taxable, and there is nothing to file with VA. The levers left are the withholding you set in myPay and your state's rules. If that describes you, the work is a short one: set withholding so April doesn't surprise you, then read the state checklist below.

What happens if you file a VA claim now or later?

You can file now (option 2) or wait 2 or 5 years (option 3). VA usually pays from the date it receives the claim or an intent to file. Back pay reaches to the day after separation only when you file within 1 year of leaving service. After that, every month of waiting is a month of compensation you don't get.

Here is what the delay costs in a hypothetical case. Troy, 66, and Olga, 63, have $900,000 across the TSP and IRAs, two pensions and TRICARE For Life, which requires Part B. Troy retired from the Marine Corps, then spent 18 years under FERS. Olga is a retired nurse. He receives $3,000 each month in retired pay and has never filed a VA claim for hearing loss and a knee injury from service.

Assume, for illustration, a 30% rating paying $550 each month. Under 50%, VA pay replaces the same amount of retired pay, so Troy's cash stays the same. Only the tax changes. $550 × 12 = $6,600 a year moves from taxable to tax-free. At an assumed 20% combined tax rate, that saves $6,600 × 20% = $1,320 a year.

Waiting 2 years forfeits 2 × $1,320 = $2,640. Waiting 5 years forfeits 5 × $1,320 = $6,600. The figures assume the rating and rate stay the same. A higher rating or rate makes waiting cost more.

Here is a quick test for whether this is worth doing. Each $100 each month of VA compensation under a waiver moves $1,200 a year out of taxable income. In states that tax retired pay, it leaves state taxable income too.

At Savant Wealth Management, the VA intent-to-file date sits at the top of Troy's short list, ahead of any TSP withdrawal decision. It's the only item on the list that loses value with every month of delay.

When do the tax dates fall?

One date has no fixed day: the VA intent to file. It's the one that costs money when it slips. Federal due dates that land on a weekend move to the next business day.

A relative who prepares the return adds the amount from Troy's VA award letter to income, assuming it's taxed like retired pay. On $6,600 a year at an assumed 20% rate, that's $1,320 of tax the couple didn't owe. Catch it by matching the return's pension line to the DFAS 1099-R, because VA compensation never comes with a 1099. Fix it with Form 1040-X within the IRS time limits.

December is the last month to change federal and state withholding on retired pay in myPay for the current year. Pair it with the mid-January estimated payment if your withholding ran short.

Check your state's rules on retired pay

States split on retired pay: a few tax all of it, others exempt part or all of it. Run your state through these questions before you set state withholding in myPay.

A move between states mid-year means 2 part-year returns. The exemption usually follows where you live, not where you served.

• Full, partial or no exemption for retired pay
• Age or income conditions on the exemption
• Same treatment for the SBP annuity
• FERS annuity taxed differently than retired pay
• State withholding set in myPay

Match each option to a household

Troy has untreated service-connected hearing loss and a knee injury, so he files now. Option 2 beats option 3 on every line: the cash is the same, and each year of waiting forfeits another $1,320, so 5 years forfeits $6,600. A hypothetical Air Force retiree, 50, has no condition from service. She stays with option 1 and works on withholding and state rules.

If Troy dies, the SBP annuity is taxable to Olga. DIC, if his death is service-connected, is tax-free, and the old SBP-DIC offset has been fully phased out. A VA claim still pending at his death can be paid to Olga as accrued benefits if she applies within 1 year.

For adult children, retired pay and VA compensation stop at death. Any final unpaid retired pay goes to the beneficiary named with DFAS and is taxable to that person. Check that the designation is current.

This page covers federal treatment and general state checks only. It doesn't estimate a VA rating, explain how to file a claim (accredited veterans service organizations help with that) or cover CRDP and CRSC elections in depth. Chapter 61 disability retired pay can be partly tax-free and needs the specific DFAS and VA letters reviewed. All tax and investing outcomes carry uncertainty, and you can lose money.

Talk to Savant Wealth Management before you file

An intro call with Savant Wealth Management makes sense once a VA rating or claim is in play, or when two pensions arrive on different 1099-Rs. Bring the DFAS 1099-R, the VA rating letter, the federal return you filed last and the current myPay withholding screen.