Taxability of Military Retirement Benefits: Understanding State and Federal Laws

Military retirement benefits can be a significant source of income for service members after they leave the armed forces. However, the taxability of these benefits can vary depending on several factors, including state and federal laws, as well as the specific type of retirement benefit being received. In this article, we will explore the taxability of military retirement benefits, providing a detailed breakdown and explanation of the rules that apply.

Taxation of Military Retirement Pay

When it comes to military retirement pay, it is important to note that this income is subject to federal and state income taxes. Unlike the situation with some other types of retirement benefits, military retirement pay is generally considered taxable income. This means that service members must report this income on their tax return and pay the appropriate amount of federal income tax.

The exact taxability of military retirement pay can vary based on the state in which the recipient resides. Some states choose to tax military retirement pay, while others do not. For example, California, Montana, Rhode Island, Utah, and Vermont are known to tax all or part of military retirement pay, based on current state laws. These laws are subject to change, so it is essential to stay informed about any updates in your state's tax code.

VA Disability Compensation and Taxability

It is important to distinguish between military retirement pay and VA disability compensation. Unlike military retirement pay, VA disability compensation is generally not subject to federal or state income tax. This is because the benefit is intended to help service members and their families cope with the financial burden of disabilities sustained during military service.

For service members who receive both military retirement pay and VA disability compensation, the non-taxable nature of the latter allows them to potentially offset some of the tax burden related to their military retirement pay. However, it is crucial to consult with a tax professional to understand how these benefits interact and to ensure full compliance with tax laws.

State-Specific Tax Variations

The taxability of military retirement pay varies significantly from state to state. For example, Illinois currently does not tax federal pensions, including those received by military members. However, it is essential to recognize that this situation may change in the future. State policymakers in Illinois and other states may consider changes to pension taxation given their current financial situations.

As of now, the old military pension system that ended in 2019 for those entering active duty is still applicable to active service members and those in the Guard and Reserve. This means that the rules regarding taxability remain the same for these groups. While there may be discussions about future changes to the tax laws, the current state of affairs is clear: military retirement pay is generally taxable, unless the recipient lives in a state that does not subject it to state taxation.

Exception for Government Disability

It is important to note that government disability pay (such as Social Security Disability Insurance or a service-connected disability benefit) is generally not subject to federal income tax. This is a significant distinction that service members and their families should understand, as it means that this form of compensation is treated differently from military retirement pay.

Additionally, service members who take the Survivor Benefit Plan (SBP) and opt out of taking the mandatory Social Security tax withholding can also benefit from a reduced tax burden. The SBP ensures that a portion of the retired pay is provided to a surviving spouse or dependent, and the small amount withheld from the pension checks for this benefit is not subject to federal or state income tax.

Conclusion: Navigating Complex Tax Laws

Navigating the complexities of tax laws related to military retirement benefits can be challenging. However, understanding the distinctions between types of benefits and the specific laws governing each state can help service members and their families plan effectively for their post-military lives. It is always recommended to consult with a tax professional or the Internal Revenue Service (IRS) to ensure compliance with federal and state tax laws.