From the Mailbag: Military Retirement Pay Taxes

A retiree asks about military retirement pay taxes...here's the answer!

A recent question from a retiree highlights some confusion about taxes:

Dear Kate,

I retired from the Navy in 2005 and have been paying taxes on my retirement pay every year since.   I have friends that are retired Navy, Marines etc…. and they say they don’t pay taxes on their retirement pay.   Do I have to pay on my retirement? Is there something in writing i could read about it?   Is retirement pay considered earned income?  If so why?   I don’t work for it, and taxes were paid on every check I made from the start of my career to the end.  IRS told me any work you did for that year is earned income and taxable, and only earned income is taxable.  I’m just confused.

Please help……SKH

So, there are a couple of issues here.

Generally speaking, military retirement pay is subject to federal income taxation.  You can find that information here or here.  You are correct that you should be including military retirement income on your federal income tax return.  Some states tax military retirement pay, some states do not, and some states exempt a portion of military retirement pay from taxation.

However, disability compensation from the Department of Veterans Affairs (VA) is not taxable income.  If your friends are receiving disability compensation or other service-related compensations from the VA, they are not paying taxes on that money.  In many cases, retirees who have their retirement pay offset by VA benefits don’t make a distinction when talking about their benefits, they just call it all “retirement.”

It is not true that only earned income is taxable.  There are many types of non-earned income that are taxable, including many types of retirement income.  Other unearned income that may be taxed includes Social Security benefits, alimony, unemployment insurance, interest, dividends, and capital gains.  Specific rules may apply to specific situations, so please do not think that list is a full explanation of the tax laws applying to these types of income.  Military retirement pay is specifically subject to federal income taxes.

Without knowing their entire situations, I suspect that your friends may not be fully explaining their tax status.  Rest assured that you are doing the right thing by including your retirement income in your federal tax calculations.

Have a question about your military pay or benefits?  Use the”Tell Kate” link in the right hand column.

About the Author

Kate Horrell
Kate Horrell is a military financial coach, mom of four teens, and Navy spouse. She has a background in taxes and mortgage banking, and a trove of experience helping other military families with their money. Follow her on twitter @realKateHorrell.