Medical bonuses and taxes

[qibovin]

I just wanted to post my experiences/challenges with military medical bonuses as related to TSP contributions and income tax withholding.
Hopefully this will help some, and perhaps others may have had similar experiences with different or better "solutions" to these issues (or other issues) that might help all of us.

[qibovin]

There are a number of quirks specific to the special bonus pays that the Army pays to its medical officers.

One is that there are 4 or 5 different ones, and some are paid monthly and some as a once yearly lump sum. For TSP contribution purposes, however, they are all considered "special pay" (as opposed to "bonus pay" or "incentive pay" for which you can choose different contribution percentages) so you can only choose one contribution percentage for all your special pays, whether monthly or yearly, in addition to your separate base pay contribution percentage.

Second is that the lump sum bonuses come at different times during the year, usually July 1 and October 1 (mine actually come August 1 and November 1 because I graduated residency off cycle.)

Third is that these lump sums have taxes withheld at a uniform rate of 25%regardless of exemptions or other income. Only TSP contributions can shelter this monstrous loan to Uncle Sam.

These factors create some interesting situations that require some creative number crunching to maximize monthly cash flow and minimize your tax refund.

Disclaimer: My results may not be typical, and the extremes are probably exagerated by four children and a stay-at-home Mom. If you are a young, single military physician with no dependents or a DINK couple then you probably have not "noticed" these "quirks" in the bonus, TSP and tax systems. That's OK, just keep maxing your contributions now, while it's easy.

Here's my experience:

A couple of years ago, after my first year of home ownership (I closed in December of the year prior) I was pleasantly shocked with a February tax refund just shy of $10000. This prompted me to look into my whole tax situation to see how this could be prevented in the future. Prior to this my refunds had always ranged from about $500 to no more than $2000, still higher than it needed to be but not enough to get me excited. I had added my third child that year prior and had added an additional withholding exemption for her as well as one for the anticipated mortgage interest tax deduction. I had no idea how inadequate those withholdings would be.

When I began to research the "problem," I discovered the issues listed above. First, I was only contributing about 5% base and special pay across the board to TSP and decided that then was the time to begin maxing that allowance every year. Second, when I looked at from where that $10000 tax refund had been withheld, I discovered that >50% of my withholdings had come from the two lump sum bonuses I had received that year.

Still, the remaining monthly withholdings alone were considerably more than my entire tax liability for the year. I found a great calculator tool on the IRS website to help estimate what my tax liability would be in subsequent years and now use this annually to "plan" my tax, bonus and TSP finances.

I quickly calculated that with the manditory 25% withholding from the lump sum bonuses, even if my entire TSP allocation for the year were to offset this income, the resultant withholding would still be considerably more than my entire tax liability. And that didn't even take into consideration my monthly withholding.

So what I did was immediately lower my base pay TSP contribution percentage to 1%, the minimum required to keep the account active. I then filled out the paperwork to declare something like 21 or 23 withholding exemptions for my monthly pay based on an IRS calculator again. This basically stopped all monthly IRS withholding.

Now, remember, all the bonus pays are "special pays." I set this to 0% to maximize monthly cashflow and maximize the amount I could shelter later from the lump sum bonuses. But now I had to remember to logon to MyPay and change this number to 40-60% or so the month prior to the payment of the yearly bonus. No problem, right? But don't forget that this 40-60% contribution now affects the monthly bonuses during that month as well. Not a major issue as far as monthly budgeting, considering that it comes at the same time as a sizeable bonus, but it does make for some complicated math.

The other thing that I try to do is put a bigger chunk of the first bonus into TSP to start working for me, and let the majority of taxes come out in November right before I get much of it back a few months later as a refund.

Of course, I probably don't need to warn any veterans, but DFAS is not the most accurate and reliable accounting entity around. Last October, I increased my special pay contribution so that it would kick in for my November 1 bonus and top off my TSP, but DFAS decided they would give me a little Christmas bonus by releasing my special pay a day early, on October 31. This was a Sunday of all days, and I still haven't figured out how or why they did this, but suffice it to say that a year's worth of planning went out the window with that one slick move. Uncle Sam got I nice Christmas bonus from that and got to keep a little more come refund time because there wasn't enough year left to contribute the difference back into TSP. Pay inquiries basically just said "so sad, too bad."

Nevertheless, with this strategy, even with the screw up I mentioned, I was able to get my tax refund down to under $3000 this year. This year I am attempting to avoid the roller coaster I just described a bit by keeping a small but significant special pay contribution going monthly. Basically I have calculated a percentage to offset the COL raise on Jan 1 and later a time-in-service raise to gradually increase the special pay contribution percentage to 25% without affecting my take home monthly pay. (Base pay is still at 1%)Now when I kick my special pay contribution up to 40+% it won't have as much of an impact, especially since I plan to do this two months in advance this time so as not to be foiled again by DFAS.

I will max my TSP this year, and given that my income has gone up a little and my mortgage interest has gone down a little, maybe I'll get my refund down to only $2000 that Uncle Sam gets to borrow from me interest-free. That's alright though. It's like getting a third bonus every year, just in time for Spring Break.

Hope this info is helpful to someone.

[pyriel]

Not sure if I read it but I might have missed it... Ever consider changing your W4 to Married 10? They should take less tax from you and bring up your take home. Since they are taking less tax every month, it will then lower the total tax witheld for the year which should take care of your 2k overwitheld tax from the previous year... P

[qibovin]

Not sure if I read it but I might have missed it... Ever consider changing your W4 to Married 10? They should take less tax from you and bring up your take home. Since they are taking less tax every month, it will then lower the total tax witheld for the year which should take care of your 2k overwitheld tax from the previous year... P

That was my first strategy. I actually had to increase my W4 "exemptions" to married w/ 23 exemptions. This brought my monthly withholdings to $0, but I can't get around the federally mandated 25% from the lump sum bonuses. That's where ALL the withholdings are now coming from and it's still too much. It seems that there should be a legal process to apply for exemption from such government extorsion...anybody know of one?

[pyriel]

That was my first strategy. I actually had to increase my W4 "exemptions" to married w/ 23 exemptions. This brought my monthly withholdings to $0, but I can't get around the federally mandated 25% from the lump sum bonuses. That's where ALL the withholdings are now coming from and it's still too much. It seems that there should be a legal process to apply for exemption from such government extorsion...anybody know of one?
That is right, there is a threshold of i believe 3k and above that no matter what they automatically take out 25% federally mandated tax.
For your 23 exemptions, how did you get away with that since you are supposed to provide social security for all exemptions once you go over the minimum of 10? P