When service members retire, many expect their military pension to be taxed just like their active-duty pay — with enough withheld to cover the bill. Unfortunately, if you have more than one source of income, that assumption can lead to a costly surprise at tax time.
Here’s why.
How the Under-Withholding Problem Happens
Military retirees often have two or more income streams:
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Military retirement pay
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A civilian salary (yours and/or your spouse’s)
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Possible self-employment or investment income
The Defense Finance and Accounting Service (DFAS) doesn’t know about those other income sources. They only see your pension, so they calculate withholding as if it’s your only income.
Example:
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Pension: $30,000/year → DFAS assumes you’re in the 10% bracket.
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Civilian income: $150,000 combined → This pushes your top marginal rate into 22%, 24%, or higher.
Result: DFAS withholds far too little. When you file your tax return, you discover you owe hundreds or even thousands — plus possible IRS and state penalties for underpayment.
Why Your W-4 Matters
Each employer (or pension payer) withholds taxes independently. None of them automatically coordinate with the others. If you don’t adjust your Form W-4 for each income source, every paycheck will be under-withholding — and the shortage adds up over the year.
This is why so many military retirees — even those who have been filing taxes for decades — get caught off guard in their first year as civilians.
How to Prevent It
The fix is simple once you know the problem:
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Estimate your total annual income from all sources.
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Calculate your total expected tax for the year.
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Adjust each W-4 so that, combined, the total withholding matches your expected tax bill.
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On your pension’s W-4 in MyPay, you can either reduce your claimed exemptions to withhold more or set a flat additional amount to be withheld each month.
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Repeat this review for your civilian job’s W-4 (and your spouse’s, if applicable).
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When done correctly, your withholding will be accurate across all income streams — and you’ll avoid the April shock.
We Can Help You Get It Right
At PIM Tax Services, we work with military retirees every year who are navigating this exact challenge. We can:
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Project your full-year tax liability
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Show you exactly how to adjust your W-4 forms
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Ensure both your federal and state withholdings are correct — before it’s too late
If you’ve just retired from the military or are about to, don’t let multiple income streams turn into multiple tax headaches. Contact us today, and we’ll make sure your first year of civilian life doesn’t come with a surprise tax bill.
Below is a video I made that explains this in greater detail.