Whether or not your pension is taxed depends on the type of pension—years of service or disability—and the type of tax—federal, state, or social security.
The Federal Government and Military Retirement Pay
If you’ve spent twenty or more years in military service, you’re entitled to a military pension upon retirement. The federal government considers this pension to be income, and therefore your federal income tax is deducted from your payments. Fortunately, however, it’s not considered income with regards to Social Security taxes, so they are not deducted.
If you’re receiving Military Disability Retirement Pay, it is not considered income and your payments are not taxed by the federal government nor by Social Security. There are many specifics regarding military disability, such as when and how it was incurred, so it’s best to talk to accountants who are well-versed in the tax laws governing veteran affairs. In addition, many veteran benefits are excluded from federal income tax, so talking to someone about the benefits you receive may be a good idea.
State Taxes and Your Military Pension
Many states use their tax code to woo new residents, particularly veterans. Some have no state income tax at all, while others shield all or part of military pension income from taxation. Below is a list of the most tax-friendly states with regard to income taxes:
States that don’t charge any personal income tax:
Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming
States that don’t tax your military pension:
Alabama, Arkansas, Connecticut, Hawaii, Illinois, Iowa, Kansas, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, New Jersey, New York, Ohio, Pennsylvania, West Virginia, and Wisconsin
States that offer some special considerations regarding military pension:
Arizona, Colorado, Delaware, Idaho, Indiana, Kentucky, Maryland, Nebraska, North Carolina, Oklahoma, Oregon, South Carolina, and Washington, D.C.
That leaves only nine states that don’t go out of their way to make provisions for our veterans after their years of service: California, Georgia, Montana, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and Virginia. Hopefully over time they will also add exemptions, as West Virginia just started in 2018.
Keep in mind that some states have high sales taxes and/or high standards of living, which may mitigate the benefits of the income tax exclusion. Remember to weigh all factors before making major changes to save money on taxes.