How Are PERS Retirement Benefits Taxed?

A Public Employees’ Retirement System (PERS) provides retirement, disability, and death benefits to individuals working in public service. These plans are a component of the compensation package for many government employees. While a steady income in retirement is a benefit, understanding the tax implications is necessary for financial planning. The tax rules for your benefits differ during your working years versus your retirement years.

Tax Treatment of Your Contributions

The tax treatment of your PERS benefits begins with the contributions you make during your career. Most public employees make contributions on a “pre-tax” basis, meaning the money is deducted from your gross pay before federal and most state income taxes are calculated. This process lowers your current taxable income, providing a tax benefit each year you contribute.

Some PERS plans involve “post-tax” contributions made from your net pay after taxes have been taken out. It is important to know which type of contributions you have made, as this determines your “cost basis.” This cost basis is the total of all your post-tax contributions. This number becomes significant when you begin receiving retirement distributions.

Federal Taxation of Retirement Distributions

Once you retire and begin receiving payments from your PERS plan, the federal government will tax that income. For most retirees, monthly pension payments are treated as ordinary income, similar to wages, and subject to the same federal income tax brackets. At the end of each year, your PERS administrator will send you an IRS Form 1099-R, which details the total amount of your distributions and the taxable amount.

The cost basis from any post-tax contributions you made is recovered tax-free during retirement. The IRS provides a method to calculate the tax-free portion of your payments, known as the “Simplified Method.” This calculation spreads your tax-free cost basis out over the expected number of payments. This results in a part of each monthly check being excluded from your taxable income.

If you opt for a lump-sum distribution instead of monthly payments, the rules are different. These distributions are subject to a mandatory 20% federal tax withholding. To avoid this immediate tax hit, you can execute a direct rollover, transferring the funds to another qualified retirement account like a traditional IRA. This action defers the income tax until you withdraw money from the new account.

State-Level Tax Rules for PERS Income

The taxation of your PERS benefits at the state level is separate from federal rules and varies widely. Because there is no single standard, it is important to understand the regulations in your state of residence during retirement. Your tax liability can differ depending on where you live.

Some states completely exempt PERS income from state income tax. Other states offer partial exemptions or tax credits, which may be contingent on your age or total income. For instance, a state might not tax the first $20,000 of retirement income for individuals over age 65. In contrast, a number of states tax PERS benefits fully, treating them as ordinary income.

You cannot assume the rules of one state apply to another. The most direct course of action is to get information from your state’s department of revenue or tax agency. Their official websites are the authoritative sources for these rules. Consulting with a local tax professional is also recommended.

Taxation of Disability and Survivor Benefits

PERS plans provide benefits in situations outside of a standard service retirement, which have their own tax considerations. For members who retire on disability, the tax treatment of their benefits depends on their age. If you are under your plan’s minimum retirement age, your disability payments may be tax-free at the federal level until you reach that age. This is contingent on meeting the IRS definition of being totally and permanently disabled.

Survivor benefits, paid to a designated beneficiary after a PERS member’s death, are also subject to taxation. The tax liability passes to the person receiving the income. These benefits are taxed to the beneficiary in the same manner they would have been taxed to the original retiree, meaning the payments are considered ordinary income.

The beneficiary is also entitled to recover any of the member’s remaining cost basis tax-free. A beneficiary can exclude a portion of each payment from their taxable income until the entire cost basis has been distributed.