Transition Tip: Taxes
Everyone who leaves the military is forced to endure a tortuous ritual known as the Transition Assistance Program (TAP).
For those unaware it's a fun game where, over the course of a few days, you are locked in a room of other soon-to-be civilians and lectured about 1,000 things—and have to ID the 10 things that apply to you.
The one thing I'm pretty sure no one ever mentioned was the T-word: Taxes.
Why? Who knows.
But....my (extremely) informal survey of fellow military retirees tells me almost everyone gets punched in the face come tax season.
Disclaimer: I am not a tax expert, so validate everything you're about to read.
Claimer: This happened to me. TWICE. I'm apparently not wise enough to debrief the first sortie, and did it all again—and paid the price.
The Setup
Let's assume you retired from active duty and joined the "check of the month club" and are now working at a new job. To keep things simple, let's also assume you went on terminal leave and enjoyed every day of it by NOT starting your new job (i.e. no income overlap). Finally, let's assume you are married; your spouse now lives a life of luxury and does not work.
Life is good, and you have 2 buckets of income now. Here's how they look to the IRS.
Here's how it looks.
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The Take Down
OK, so let's add it up, where $ is retirement income, and $$$ is the new job:
It's so simple that even a caveman can do it. Turns out though, the IRS can't. When filling out your W-4 (withholding form) for each income, the auto-withholding (Single, M0, M1, etc.) only considers the income associated with the W-4. The system isn't smart to consider both incomes.
Here's the basic math:
There is a high chance that Life 2.0 has put you in the 24% tax bracket (good!), but it's also baked in a nasty bill to the IRS (bad!).
The result: Even if you've claimed no exemptions for withholding (i.e. M0), you'll end up with a surprisingly large bill (think $5k-15k!) come tax season.
The Fix
The bottom of the W-4 has a section to specify "extra withholding" to increase your income tax withholding and reduce your bill come tax season.
How much extra do you need to withhold? You can guess, or use this IRS Tax Withholding Estimator.
$$$$
If you're married to a big breadwinner or had a lucrative side hustle, congratulations—you probably already learned this lesson. For everyone else, spend a few minutes of adulting to sort out your withholding situation; it's worth it.
B.I.G. was right: Mo' Money Mo' Problems.
Airline Transport Pilot with Military Experience
1 年Step 2 is another way to increase withholding, but it basically doubles withholding, so you would have higher risk of overpayment. Also, just to dispel a common misconception: the tax rate is tiered. A lot of folks think that you pay the rate at the bracket you are in based on AGI. This is not the case. You pay the rate at each tier. So in this example, the military retirment income is still taxed at 12 percent and the income above it is taxed at that next tier up and so on.
MBA, Lt Col., USAF (Ret)
1 年Wish I had read this 2 years ago. I overlooked the same thing and am paying the price for the second year… now I will make the necessary adjustments like you recommend. Glad I’m not the only one in this boat.
Retired Military | Servant Leader
1 年Great tip!! I got the bill my first year that I was retired.
Intel Strategy and Policy, Principal at MITRE
1 年In addition to withholding extra money, you could also consider reducing taxable income in a few ways. Does your new company have an FSA/HSA or 401K? Both will reduce your tax burden and help you out. But yes…we all get somewhat punched in the face come tax season. Good luck to all!!