Chapters

00:00 Introduction to PERS Benefits and Taxes

00:30 Understanding Payroll and Income Taxes

02:52 Taxation of Partial Lump Sum Options

04:57 Taxation of Monthly Retirement Benefits

06:35 Taxation of Survivor Lump Sum Benefits

08:17 Taxation of Survivor Monthly Benefits

09:14 Charitable Beneficiaries and Tax Efficiency

10:27 Action Items for Minimizing Taxes

11:06 Preview of Next Video and Calls to Action

12:14 Disclaimer

Transcript

Hi everyone, I'm Ryan Earley, vested PERS member, former school finance officer, current financial planner, and host of the PERS Pro YouTube channel. Today, we are diving deep into the world of taxes, specifically how your and your beneficiaries' various Mississippi PERS benefits are treated at both the federal and state levels. Let's get started.

To understand retirement taxes, we first have to look at what you've been paying your entire career versus what changes the day you retire. First, there's payroll tax, also known as FICA. This covers Social Security and Medicare. While you've paid this your entire career, the good news is that PERS pension income is not subject to FICA. This is an immediate 7.65 % savings compared to your working years. Next is income tax.  These are the federal and state levies on what you earn. For Mississippi PERS members, the answer is mixed. Your benefits are subject to federal income tax, but thanks to Mississippi law, they are 100 % exempt from state income tax. Finally, we have capital gains. This is the tax on profits from selling assets like stocks or real estate. This does not apply to your PERS benefits. It only applies to investments you hold outside of the retirement system. 

The biggest tax cut retirees get is the immediate elimination of the 7.65 % FICA tax and the 4 % state tax on their retirement income. However, your PERS benefits are still considered taxable income for federal income tax purposes. 

The IRS groups your money into three buckets. Knowing where PERS fits is key to your tax withholding strategy. First, we have earned income. If you decide to go back to work part-time or pick up a consulting gig after retiring from PERS, that money is considered earned income. It's subject to federal income tax, Mississippi state income tax, and don't forget the 7.65 % FICA tax for Social Security and Medicare. Next, we have unearned income. This is the passive money your assets make for you. Things like interest from your savings account, dividends from stocks, or capital gains when you sell an investment. Both the IRS and the state of Mississippi will want their share of this bucket.  Finally, there's the other or retirement income bucket. This is where your Mississippi PERS pension lives, along with Social Security and your deferred comp withdrawals. While the federal government treats your pension as ordinary taxable income, here is the big Mississippi bonus. Our state does not tax retirement income. Every penny of your PERS check is 100 % exempt from Mississippi State income tax. 

Let's talk about the partial lump sum option.  This is where most retirees make their biggest tax mistake. Remember, a partial lump sum option is taxed at ordinary income tax rates for federal income tax purposes and is exempt from state income taxes. 

Let's look at an example. Assume we have a married couple, both PERS members, each having average compensation of $65,000 at retirement.  They both retire at age 58 and each decide to take a 12-month partial lump sum option totaling $30,000. Here's the tax trap. If they retire in December, they already have earned $130,000 in salary for the adding $60,000 in partial lump sum options pushes their total taxable income up to $157,800 for the year. Compare that to if the couple had taken the same partial lump sum option, but instead retired in June. Their base salary is cut in half and their total taxable income is 50 % less. 

In fact, if we calculate the federal income taxes on these two amounts, retiring in December versus June, pushes them from a 12 % to 22 % marginal federal income tax bracket, and they end up paying $13,500 more in federal income taxes. Their effective rate therefore increases from 8.5% on all income retiring in June to 12.7 % on all income retiring in December. This is the power of proper retirement and tax planning, a decision seemingly as easy and simple as deciding what month to retire can cost the retiree tens of thousands of dollars in additional taxes. 

I also want to remind PERS retirees, if you are younger than 55, when you separate from service, that partial lump sum option is subject to an additional 10 % IRS early withdrawal penalty unless you roll it over. For our couple here, that would be an additional $6,000 penalty just for taking the $60,000 cash before age 55 on top of the normal federal income tax is calculated here.

Now let's look at how a PERS retiree's monthly benefits are taxed.  Remember, monthly retirement benefits are taxed at ordinary income tax rates for federal income tax purposes and exempt for state income tax purposes. 

Let's look at an example. Let's assume we have a couple both looking to retire at age 57 with 28 years of service and $65,000 average compensation. While working, this couple brings in $130,000. Between federal taxes and Mississippi state income tax, they are handing over more than $15,000 in taxes to the government.  But look what happens the moment they retire. Even though their gross income drops to $78,000, their tax bill drops significantly. First, the Mississippi State income tax goes to zero. While they had to pay over $4,000 as workers, the state now views their entire PERS benefit as exempt. At the federal level, because their income is lower, they are no longer in the 22 % tax bracket. They've dropped into the 12 % tax bracket and their federal tax bill is cut by more than half. 

The bottom line? Their total tax burden drops from over $15,000 down to roughly $5,000 and that is a $10,000 a year savings that stays in their pocket.  Their total federal and state effective tax rate on all income drops from 11.8 % to 6.4%. This exercise ignores the 7.65 % FICA tax that also no longer needs to be paid. This is the perfect time to remind retirees to complete or update their PERS federal tax withholdings on PERS Form W-4P to reflect what they actually believe they will pay in federal income taxes during retirement.

What happens if a retiree passes away early? How are the survivor benefits taxed if the retiree had chosen the max option or option one and the survivor receives a lump sum payment? The lump sum payment is taxed differently depending on if the payment is made directly to the beneficiary or rolled over into an inherited IRA. 

Let's look at an example. Let's assume a PERS retiree dies at age 65 and that retiree named her sister as the beneficiary.  The sister is 59 and has an $85,000 salary working for another employer. The PERS contribution and interest lump sum refund is determined to be $100,000. If the sister chooses direct cash, the IRS views that entire $100,000 as ordinary income in the year of receipt. When added to her $85,000 salary, her total taxable income jumps to $185,000.

This single decision could push her from the 22 % tax bracket all the way into the 24 % tax bracket, resulting in a large tax bill due the following April. However, by choosing an inherited IRA, she can keep those taxes deferred. Under the current 10-year rule, she doesn't have to pay taxes on the full amount today. Instead, she has 10 years to strategically withdraw all the money. This allows her to take smaller distribution during years when her other income might be lower keeping her in a much friendlier tax bracket throughout that 10 year period.  And here's the best part for Mississippians, regardless of which path she chooses, the state of Mississippi will not tax this survivor lump sum benefit. Whether it's a direct payment or a distribution later from an inherited IRA, it remains 100 % exempt from state income tax.

How are the survivor benefits taxed if the retiree had chosen option 2, 3, 4, 4A, or 4B and the survivor receives a monthly check? At the federal level, the IRS views these monthly checks as ordinary taxable income, just like the original retiree's pension. However, because these are PERS retirement benefits, they remain 100 % exempt from Mississippi State income tax. Whether you are receiving your own PERS pension, a survivor benefit, or both, the state of Mississippi does not take a single penny.

If the survivor is a spouse, there are other tax planning opportunities by being able to file a joint return in the year of death, maximizing deductions, and possibly doing Roth conversions to minimize federal income taxes on the benefits received. There may also be social security planning opportunities for the surviving spouse. 

What if you name a  501c3 charity as your beneficiary for a lump sum or the remainder of a 4b period? Well, the federal income tax story changes completely.  If you're looking to leave a legacy, naming a charity as your PERS beneficiary is one of the most tax efficient moves you can make. 

Let's look at an example. In this scenario, a retiree has a remaining account balance of $100,000. If that money goes to an individual heir, like a child or a sibling, the IRS is going to want its cut. If that heir is in the 22 % tax bracket, nearly one fourth of your legacy, or $22,000, disappears into taxes before your recipient ever sees it.  They only walk away with $78,000. 

But look at the charity row. Because 501c3 organizations are tax exempt, they don't pay a single penny in federal income tax on retirement distributions. When you name your church, university, or favorite nonprofit as the beneficiary, they receive the full $100,000. By choosing the charity, you aren't just giving money, you're essentially capturing that $22,000 that would have gone to the IRS and redirecting it to a mission you care about. It results in a 28 % increase in the actual impact of your gift. And remember, just like with individual beneficiaries, Mississippi law ensures that no state income tax is owed on these PERS distributions, regardless of who receives them.

If you care about minimizing taxes, here are your action items for today. One, calculate your tax cut. Compare your current salary to your projected PERS benefit. Calculate the difference in FICA, federal, and state income taxes to determine your retiree tax cut. Two, compare PLSO timing. If you plan to take a cash partial lump sum option, consider retiring earlier in the year so your salary for that year is lower, keeping your total income in a lower tax bracket. Three, educate your beneficiary. Make sure your beneficiary understands the impact on their federal and state income taxes that their potential survivor benefits either as a lump sum or monthly benefit will have on them.

In our next video, we'll explore “What health insurance options does a Mississippi PERS retiree have?”  Please make sure you subscribe so you don't miss this and other videos in our new retirement series. If you found this video helpful, can thank me by hitting the thumbs up button and sharing it with other PERS members. If you have a follow up question about PERS or anything else related to personal finance, please visit our website at perspro.ms click YouTube, and submit your question or topic for a future episode. 

And finally, if you're looking for a financial planner that specializes in helping PERS members plan for retirement, including building retirement strategies to minimize taxes, please visit our website at perspro.ms to learn more about our firm and to schedule your initial consultation. 

Thank you for your valuable public service to the state of Mississippi. We'll see you next time.

Disclaimer, this video is for educational and informational purposes only. Neither the host nor this YouTube channel are officially affiliated with, endorsed by, or sponsored by the Public Employees Retirement System of Mississippi. Always consult a qualified tax or finance professional for advice specific to your situation.