The u s capitol building lit up at night by Pierre Blaché courtesy of Unsplash.

Separated From Federal Service? The First 90 Days Can Shape Your Taxes This Year

Austin Costello, CFP® |

Many former federal employees are caught off guard in April when their tax bill comes in higher than expected. It’s rarely one big decision that causes it. When separated from service, it’s usually the layering of income like severance, leave payouts, withdrawals, and new wages. Most of that stacking happens in the first 90 days after leaving government service. Since they all land in the same tax year, seeking professional guidance to determine what’s next will help with this transitional period. 

Whether the separation was voluntary or the result of workforce reductions, those first few months are typically spent figuring out what comes next. Income, benefits, and searching for a new job all take priority. Tax planning usually doesn’t. But the timing of when income hits during this window can quietly shape your tax outcome for the entire year.

A Different Kind of Income Year

During federal employment, income is predictable. Paychecks are steady, and taxes are withheld automatically. After separation, that structure disappears.

Instead of one consistent stream, income may come from multiple sources:

  • Final wages 
  • Lump-sum annual leave payout 
  • Severance pay 
  • Unemployment compensation 
  • Withdrawals from the Thrift Savings Plan (TSP) 
  • Earnings from a new job later in the year 

Annual Leave Payouts: A One-Time Spike

Unused annual leave is paid out in a lump sum, often sizable for long-tenured employees, and is fully taxable in the year received. The way taxes are withheld from the annual leave payout oftentimes catches people off guard. 

When you get a one-time lump sum like a bonus or the annual leave payout, the government will withhold taxes from that paycheck as if you were going to receive that amount for every month of the year. That could lead to a significantly higher withholding than what you truly “should” owe. 

If you withhold the proper amount on all your other income, you’ll receive a refund of the excess amount when you file taxes for that year. Or, with a bit of forward thinking, you can use the “extra” withholding to pay taxes on a Roth Conversion, or reduce the taxes withheld from your pension for the year. 

The important thing to know is that, if you do get a refund the following year, that may not be a normal occurrence if it was due to the one-time annual leave payout. 

Pension Payments: Familiar, but Misleading

When you separate, you’ll fill out a W-4P for your pension withholding, which is similar to the tax withholding form you complete for your regular pay. These forms oftentimes leave people confused about what to include and what not to include. On top of you and your spouse’s employment income, you should include adjustments for investment income and Traditional Retirement Account (TSP) withdrawals. Without doing this, the IRS will assume your income is lower than it is, and will withhold taxes from your pension at too low of a rate. 

Additionally, the FERS pension does not automatically withhold state taxes. In order to set up state withholding, you must log into the OPM system and separately request it. 

Severance Pay

In certain scenarios, if you were involuntarily separated from service, you may be entitled to Severance Pay. It’s treated as ordinary wages, which are fully taxable and typically withheld at a flat 22% supplemental rate.

That flat withholding can create a false sense of accuracy. If you wind up getting another job and have the new income on top of your severance pay, your actual tax liability may be higher than what was withheld. In this case, it may make sense to withhold extra from your pay at the new job to make up for potential under-withholding on the severance. 

TSP Withdrawals and Timing

Some individuals tap their TSP during a transition. Traditional TSP withdrawals are taxed as ordinary income, while Roth withdrawals may be tax-free if certain conditions are met. But it’s important to note that timing matters.

If you separate during or after the year you turn 55 (age 50 for certain public safety roles), you may avoid the 10% early withdrawal penalty. If you leave earlier and access funds before age 59½, that penalty may apply unless an exception is met.

Additionally, the TSP does not withhold state taxes. If you take a distribution from the TSP, you either have to make an estimated payment for your state tax liability or withhold those taxes from another source. If you don’t pay your state taxes and you wait until you file taxes to discover what you owe, you may be hit with underpayment penalties. 

Lower-Income Windows

Not every transition year results in higher income. In some cases, there’s a gap between jobs that lowers total income for the year. That can actually create opportunity.

Lower-income years may allow for:

  • Strategic retirement withdrawals 
  • Partial Roth conversions at lower tax rates 
  • Adjustments that reduce future required distributions 

These windows are temporary and highly situational. When recognized early, however, they can be valuable.

Why Coordination Matters

Most tax issues in transition years don’t come from bad decisions. Instead, when decisions are made in silos, it’s the lack of coordination that is where people usually run into issues. 

A CPA often sees the outcome after the fact and a financial planner focuses on long-term strategy. But during a transition year, decisions happen in real time. Aligning on when to take income, how much to withhold, and whether to draw from retirement accounts can turn a reactive tax situation into a managed one.

The First 90 Days Set the Direction

The early months after separation are busy. Taxes aren’t top of mind, but many of the decisions you make during that time will determine your tax outcome. For those separated from federal service, the first 90 days act as a preparation period. Intentionally coordinating each part of your financial life can offer a clearer picture of your tax situation and set you up for success at tax time and beyond. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 

This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor. 

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

Austin Costello is a certified financial planner with Capital Financial Planners. If you don’t feel confident in your current or future retirement withdrawal strategy and would like feedback, you can register for a Retirement Readiness Meeting. For topics covered in even greater depth, see our YouTube page.