How Military Retirees Can Avoid a Nasty Tax Surprise Next Year

My husband retired from the military last year and started a new job. I just filed our tax return and was surprised that we owed money because of his military pension. What can we do to avoid owing a lot of money when I file our tax return next year?

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Your situation is not unusual. The IRS says that almost half of the unpaid taxes owed by current and retired federal employees at tax time are owed by retired military. Many military retirees have too little money withheld from their pension payouts for taxes because they calculated their withholding based on that income alone. But if they get a new job after they retire or if their spouse works, they might jump to a higher tax bracket and owe more than they expected.

When you retire from the military, you fill out Form W-4P to tell the Defense Finance and Accounting Service how much tax to withhold from your monthly retirement pay. Military retirement pay is subject to federal taxes but is excluded from state income taxes in some states (see Which States Won’t Tax My Retirement Income?). If you need to boost withholding, you can call the DFAS Retiree Pay customer service number at 800-321-1080 or make the changes in your myPay account online at mypay.dfas.mil. See the IRS’s Federal Income Tax Withholding After Leaving the Military fact sheet for more information.

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Or you can have more money withheld from your paychecks at your current job. File a new form W-4 with your employer’s human resources department claiming fewer allowances (the fewer allowances you claim, the more tax is withheld). See Set Your Tax Withholding Right for more information.

Your take-home pay will decrease after you submit the new W-4 reducing the number of allowances, but you’ll owe less money when you file your taxes in the spring. If you only owed a few hundred dollars this year, you may want to keep the extra money in your paychecks and be prepared to pay up at tax time. See IRS Publication 505, Tax Withholding and Estimated Tax, for more information.

Veterans Administration disability compensation generally is not taxable. See the IRS’s Information for Veterans with Disabilities for more information.