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What Every Railroader Should Know About Taxes and Railroad Retirement Thumbnail

What Every Railroader Should Know About Taxes and Railroad Retirement

Tier 1 Tier 2 Retirement Financial Planning Taxes

A hard earned benefit to all railroad employees is the retirement annuities that are administered by the Railroad Retirement Board. However, as the expression goes, “ there is no free lunch”. Let’s look at some of the important tax rules that will affect every railroader.

For the purpose of this article we will look at the tax provisions of the Age and Service Annuity.  We will eventually look at Disability Annuities in another article in the future. The Age and Service annuity consists of two parts, Tier 1 and Tier 2. Tier 1 is identical to Social Security for the most part and Tier 2 acts much more like a traditional annuity. 

Pre- Retirement Taxes > funding the Railroad Retirement Annuity

The two tiers of the railroad retirement annuity are funded by payroll taxes that are collected from the employees and the employer.  Regarding Tier 1, employees have 7.65% of their pay deducted from each paycheck that funds Tier 1. The math breakdowns is as follows: 6.20% for railroad retirement and 1.45% goes to Medicare. The employer pays the same amount for each employee. Once the employee earnings reach $132,900 in 2019, the 6.20% will stop being collected for the Tier 1 portion. However the 1.45% for Medicare continues with no earnings limit. Another 4.90% is deducted from the employee paycheck for Tier 2 taxes with an employer kicking 13.10% also for Tier 2 funding. The Tier 2 tax stops when the employee has earned $98,700 for the year.

Retirement Taxes>  taxes on your Railroad Retirement Annuity    

Well now that you have paid taxes your whole career for the Railroad Retirement Annuity, it is only right that the federal government has decided it will also tax your benefits you will be receiving in retirement. The tax payments will be distinct for Tier 1 and Tier 2. Lets’ start with the taxation of Tier 1 annuity benefits.

The taxation of Tier 1 benefits is a function of two amounts:

  1. The total amount of Tier 1 benefits received, and
  2. The amount of you other income.

The higher amount of Tier 1 benefits received during the tax year and the higher the income from other sources (including tax exempt income), the more likely it is that you will have to include a portion of your benefits in taxable income. Specifically, if your modified adjusted gross income (which includes tax-exempt income) for the tax year plus one-half of Tier 1 benefits received, (otherwise called provisional income) during the tax year exceeds the “base amount,” then the lesser of the following two amounts must be included in gross income:

  1. 50% of the Tier 1 benefits received during the year; or
  2. 50% of the amount by which the provisional income exceeds the base amount.                                                                                                                                  

    The base amount is:

  • $32,000 for married individuals filing jointly;
  • $0 for married individuals filing separately; and
  • $25,000 for all others

For railroad retirees with provisional incomes above $44,000 for married individuals filing jointly, $0 for married individuals filing separately, and $34,000 for unmarried individuals, gross income will include 85% of your Tier 1 benefit received for that year.

Provisional IncomeMarried Filing JointlySingle
0% Taxable<$32,000<$25,000
50% Taxable$32,000 - $44,000$25,000 - $34,000
85% Taxable>$44,000>$34,000

Example of Tier 1 Taxation:

Casey and Mary Jones, who file jointly, received $20,000 in Tier 1 benefits. They also have municipal bond interest income of $4,000, and their AGI is $43,000. Let’s do the math of their taxable Tier 1 benefits:

  • $43,000 AGI + $4,000 municipal bond interest + $10,000(1/2 Tier 1 Benefits)= $57,000
  • The Jones are above the $44,000 threshold
  • Between $32,000 and $44,000 (which is a $12,000 range), the Jones would take 50% of that amount; so 50% of $12,000 means that $6,000 will be subject to taxation.
  • $57,000 -$44,000 = $13,000 above the threshold range
  • You would take 85% of the $13,000, which equals $11,050
  • $11,050 + $6,000 = $17,050
  • The Jones would compare this to 85% of the Tier 1 benefits of $20,000, $20,000 x .85 = $17,000 ( that would be the maximum amount that could be taxed)
  • Since $17,000 is less than $17,050, then $17,000 is the amount that will be taxed.

While calculating Tier 1 taxes can be a bit confusing, the taxes on Tier 2 benefits are very straight forward. All Tier 2 benefits are calculated at Ordinary Income Tax Rates. So whatever tax bracket you are in at retirement is the tax rate that is applicable for your Tier 2 benefits.

Another bonus which really affects retirees in high income tax states is that Railroad Retirement is exempted from state and local taxes.

When doing retirement planning, it is very important to understand the tax implications of your income. By doing this you will have a better understanding exactly how much income your will really have in retirement. It would be advisable to sit down with a retirement specialist to understand your specific situation. Highball Advisors works exclusively with Railroad Professionals and we be glad to assist you with your retirement planning.

Get Your Free Railroad Retirement Assessment

Photo by Ben Sutton

Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. Highball Advisors encourages you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Highball Advisors, and all rights are reserved.