A common misconception among federal employees is that a career spent serving the public and paying into government systems results in a significant tax break during retirement. Many believe that because they have contributed to Social Security and the Federal Employees Retirement System (FERS) for decades, the government will offer a “thank you” in the form of tax-exempt income. Unfortunately, for the vast majority of federal retirees, this is simply not the case. In reality, most of your retirement income will be exposed to federal income taxes, and potentially state taxes as well. Understanding how each component of your retirement portfolio is treated by the IRS is essential for accurate financial planning and avoiding unpleasant surprises when you file your first return as a retiree.
The federal retirement “three-legged stool” typically consists of the FERS basic annuity (your pension), the Thrift Savings Plan (TSP), and Social Security. Some employees may also receive the FERS Supplement if they retire before age 62. Each of these income streams is handled differently under the tax code.
The FERS Basic Annuity
Your federal pension is one of the most stable parts of your retirement, but it is not tax-free. However, it is one of the few areas where you receive a small reprieve. Because you made after-tax contributions to the FERS system while you were working, the IRS does not tax you on the portion of your pension that represents a return of your own money.
For most federal employees who retired recently or are about to retire, approximately 95% of their pension is considered taxable income. The remaining 5% represents your prior contributions. If you were hired after 2013, you likely paid a higher percentage of your salary into the pension system (FERS-FRAE), which means a slightly larger portion of your pension—perhaps 10% to 15%—may be tax-free. Generally speaking, however, you should prepare for 85% to 95% of that monthly check to be added to your taxable income and taxed at ordinary income rates.
The FERS Supplement
The FERS Supplement, often called the Social Security Supplement, is designed to bridge the gap for those who retire before they are eligible for Social Security at age 62. While it serves as a valuable bridge, the tax treatment is straightforward: it is 100% taxable at the federal level. Unlike the pension, there is no “return of contribution” component to the supplement, so every dollar you receive counts toward your total taxable income for the year.
The Thrift Savings Plan (TSP)
The taxability of your TSP withdrawals depends entirely on which “bucket” the money is coming from: Traditional or Roth.
The Traditional TSP is the default for most long-term federal employees. Because these contributions were made pre-tax, the IRS has been waiting to collect its share. Every dollar you withdraw from a Traditional TSP account—both the original contributions and the decades of growth—is taxed as ordinary income. It is important to remember that these are not taxed at the lower capital gains rates; they are taxed just like a paycheck from a job.
Conversely, the Roth TSP offers a powerful tax advantage. If you made contributions to the Roth side of the TSP, those dollars were already taxed before they went into the account. As long as you meet the requirements for a qualified distribution, the withdrawals are 100% tax-free. This includes all the growth and earnings. For retirees, having a mix of Traditional and Roth assets can be a strategic way to manage their tax bracket by choosing which account to pull from in a given year.
Social Security Benefits
Perhaps the most misunderstood area of retirement taxation is Social Security. Many people believe that because they paid Social Security taxes (FICA) their entire lives, the benefits should be tax-free. While that is true for some low-income retirees, most federal employees will find that up to 85% of their Social Security benefits are taxable.
The IRS uses a formula called combined income to determine how much of your benefit is taxable. Combined income is the sum of your adjusted gross income, non-taxable interest, and one-half of your Social Security benefits. For 2026, these federal thresholds remain unindexed for inflation, meaning they stay at the same levels as previous years. If you are a joint filer and your combined income is between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. If your combined income exceeds $44,000, up to 85% of your benefits become taxable. For single filers, these thresholds are even lower: $25,000 to $34,000 for the 50% bracket, and anything over $34,000 for the 85% bracket. However, for the 2026 tax season, a new senior deduction from the “One Big Beautiful Bill” may help offset these costs for those over age 65. Even with this new deduction, the high value of federal pensions and TSP distributions means the majority of feds will still clear these taxability hurdles.
The State Tax Factor
While federal taxes are a constant regardless of where you live, state taxes vary wildly. Some states, like Florida, Texas, and Nevada, have no state income tax at all. Other states may exempt Social Security but tax pensions, or they may exempt a specific dollar amount of retirement income. It is vital to research the specific tax laws of the state where you plan to reside, as this can significantly change your net spendable income.
Planning for the Future
The reality for federal retirees is that the vast majority of their income will be subject to the “tax man.” This highlights the importance of tax diversification. Utilizing Roth accounts or considering Roth conversions can provide “tax-free” buckets of money that allow you to cover large expenses—like a new car or a dream vacation—without pushing yourself into a higher tax bracket or triggering higher taxes on your Social Security.
Understanding these rules now allows you to set aside the proper amount for withholdings and avoid a massive bill in April. Retirement is a time to enjoy the fruits of your labor, and a clear tax strategy is the best way to ensure those fruits aren’t overly picked by the IRS.