Which Federal Employee Benefits can help me lower my TAXES?
This question is actually incomplete and needs further clarification. Is your objective to lower taxes NOW or LATER?
This clarification is critical and is the basis for the practice of “tax planning.”
Tax planning puts you in the driver’s seat. Instead of scrambling to minimize taxation at the end of each year (or before April 15th of the following year), tax planning allows you to see today’s tax options compared to future tax options. When you see all your options, you can structure your income sources (as well as your estate) in the manner that minimizes the amount of tax you will ultimately have to pay.
I call this “winning by NOT losing!”
Other benefits of lowering your taxable income:
We all know lowering your taxable income will directly result in you paying less tax. But here are some other areas where a reduced income will benefit you:
- Student Aid – when applying for student aid (for your child or for yourself), eligibility is based on a number of factors, one of them being income. Income is determined by AGI (adjusted gross income) which is something you can influence by participating in some of your Federal Benefits.
- Income-based repayment of Student loans – your monthly student loan obligation can possibly be determined by your AGI. The lower your AGI, the lower your monthly obligation can be. Once again, participating in some of your Federal Benefits can lower your AGI.
- Ability to deduct student loan interest – If you make too much money, you could lose the ability to deduct your student loan interest. By participating in some of your employee benefits, you can lower your AGI and qualify for a student loan interest tax-deduction.
- Eligible to make IRA (ROTH or Traditional) contributions – Your ability to contribute to an IRA, or to receive the maximum tax deduction in an IRA is tied to your AGI. Lowering your AGI can make you eligible to participate in IRA, even if you’re already maxing out your TSP!
The downside of lowering your taxable income:
Do I lose anything by reducing my income this year? Possibly. Here are a few things to consider:
- Getting a Loan – Most lenders will want proof of income to determine your borrowing capabilities. By lowering your taxable income, you may not be able to show the income levels required to get a certain loan amount.
- Restricted Funds – Money that you put into certain benefits may lower your taxes but also may have imposed certain restrictions or liquidity challenges. For example, money you put into your TSP is not accessible until retirement. Early access usually comes with a penalty. If you need that money in a pinch it may not be so easy to access.
- Reduced Social Security Benefit in the future – This is usually not so significant, but still needs mention. Your future social security benefits are based on the amount you pay in Social Security taxes (also known as FICA). Your FICA tax is determined by your gross income. Some of your employee benefits will reduce your gross income, thus reducing your FICA tax, thus reducing your future Social security benefit.
- Future tax-free implications – This is the classic Roth vs. Traditional question. With a Roth TSP or Roth IRA you will have tax-free income for retirement. A similar idea applies to muni-bond investments where you could receive tax-free interest.
- Another common future tax implication is the RMD. Money that you put into a Traditional IRA (or TSP) will need to be taxed at some point in the future. The IRS forces Required Minimum Distributions (RMDs). That’s not necessarily a problem, unless they are forcing you to receive income you don’t need. The “unneeded” income will be taxed, and likely cause you a tax loss.
Which Federal Benefits can help me lower my TAXES?
Below, I will list of each Federal Employee Benefit and explain its tax benefit:
CSRS & FERS contributions – Your contributions into your retirement system (7% for CSRS, 0.8%-4.4% for FERS) are taxed in the year you contribute but are returned to you once you start receiving your Federal pension. Meaning, when you receive your pension it will not all be taxable – there will be a portion of your pension which is a return of your post-tax contributions into your retirement system. (Some paystubs actually record your contributions in a box titled “Cumulative Contributions,” usually box #19. But the figure in that box may not be accurate, especially if your agency has changed payroll providers over the years.) When you retire, OPM will calculate the non-taxable portion of your pension.
Thrift Savings Plan (TSP) – You have a choice between the Traditional TSP or the Roth TSP. The Traditional TSP will lower your taxable income in the year you make that contribution but you will be taxed in the future when you withdraw those funds. The Roth TSP will not lower your taxable income in the year you contribute, but instead will provide you with tax-free income in the future when you withdraw those funds. (Which one is better? I will deal with that in a later article.)
TSP “Catch-UP” contributions – This benefit allows you to contribute even more to the TSP than ordinary limits. It is available to anyone who is “technically” age 50 or older. I say “technically” because you don’t have to be 50 at the time you contribute, so long as by the end of that calendar year you trun 50. So someone age 49 who will turn 50 in December of a given year my participate in the “catch up” throughout that entire calendar year. The tax benefits are the same as TSP, above.
CSRS Voluntary Contributions Program (VCP) – This is possibly the best kept secret for CSRS employees. The VCP is a form of savings account that is funded with post-tax dollars, grows with interest on a tax deferred basis, and then at retirement can be converted into an annuity or rolled into an IRA. Both the annuity option and IRA options will lower your future taxable income. (Which option is better? I will discuss in a future article.)
Federal Employee Health Benefit (FEHB) – FEHB premiums reduce your taxable income while you are at work thanks to a tax arrangement known as “Premium Conversion.” This arrangement allows the part of your salary that goes for health insurance premiums to be non-taxable, meaning you will save on Federal income tax, FICA taxes (Social Security and Medicare) and, in most cases, State and local income tax. (You are automatically signed up for Premium Conversion. You don’t need to fill out a form. However, you do have the option to waive premium conversion despite the tax benefits).
Federal Employee Group Life Insurance (FEGLI) – Unlike FEHB, FEGLI premiums are NOT pre-tax, meaning they will NOT reduce your tax liability. However, FEGLI benefits (claims) are non-taxable.
Long Term Care Insurance (LTCFEDS) – This one is a little trickier than FEGLI. In general premiums are NOT pre-tax, however there are some notable exceptions:
- Long term care insurance premiums can be added to your medical expenses on your Federal tax return. If your total qualified medical expenses exceed 10% of your annual adjusted gross income (or 7.5% if you are age 65 or older – thru Dec. 2016) the excess is tax deductible. The amount of long-term care insurance premiums that you can include in your total medical expenses is subject to Internal Revenue Service (IRS) limits by age. See HERE.
- Many states offer state tax incentives to encourage the purchase of long-term care insurance.
- In a later article I will explain how to use tax-free HSA money to pay your LTC premium.
LTCFEDS benefits (claims) are not taxable.
Federal Employee Dental & Vision Insurance Program (FEDVIP) – FEDVIP premiums are NOT pre-tax, meaning they will NOT reduce your tax liability.
Flexible Spending Account (FSA) – FSAs are underutilized tax savings vehicles. They allow you to pay for some of your ordinary expenses with pre-tax dollars. Why spend your post-tax dollars when you can spend pre-tax dollars, get the same exact thing and lower your tax liability? It is worthwhile to investigate these further (I will deal with them at greater lengths in later articles). There are two types of FSA:
- Dependent Care FSA (DCFSA) – Allows you to pay for dependent care with pre-tax dollars. In general, DCFSA is the best way to pay for dependent care, however, in some instances it is actually better NOT to participate in the DCFSA but instead to take the “Child Care Credit” on your Federal Tax Return.
- Health Care FSA (HCFSA) – Allows you to pay for qualifying health, dental, vision care with pre-tax dollars. The HCFSA benefits need to be compared to Health Savings Account (HSA) benefits, because HSAs provide many advantages that HCFSA does not, including a larger tax advantage.
Telework – Working from home is not tax deductible. Even though a “home office” is a form of tax-deductible expense, that’s not going to be so for Federal Employees for one of two reasons:
- Sole use of the home office and equipment must be for business purposes
- Teleworking must be for the convenience of the employer.
Commuter expenses – Can you deduct what it costs to get you to your office? Possibly. Your agency may not provide a commuter benefit at all, but if they do it will be one of two types:
- Employer financed tax-free fringe benefit. Here, the agency pays directly for the cost of your use of public transportation or parking. The value of such benefit is not added to your gross income.
- Employee financed commuter benefit. Here, you set aside a portion of your salary pretax to pay for qualified transit, vanpooling, or parking expenses (up to the IRS allowable monthly maximum).
All these tax points are all very sensitive and should be reviewed with a qualified advisor.
Wishing you financial success!
Stephen Zelcer is part of the GovLoop Featured Blogger program, where we feature blog posts by government voices from all across the country (and world!). To see more Featured Blogger posts, click here.