If you are a retired federal employee and have filed your federal income taxes at least once, you know that part of your annuity is made up of your own contributions and the rest made by the government. And, if you’ve studied IRS Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits, you know that the tax free portion of your annuity is based on your age at which you retired and, for many of you who have elected a survivor annuity, the age of your spouse.

Until the law changed in the mid-‘80s, you would have received all of you contributions tax-free before the first fully taxable dollar was paid to you. Those days are gone forever.

Anyone with a calculator can subtract the tax free amount from the amount of your retirement contributions, which shows up on Box 1 of the 1099-R that OPM sends you each year. Since the tax-free amount is a constant, you can divide it into the contributions figure and find out when, actuarially speaking, the Internal Revenue Service expects you to die. If you die after that year, you wouldn’t expect there to be any tax-free money to pass on to your spouse or your heirs. And if you died before that, you’d expect that there would be.

That’s true, but… While Congress changed the way the IRS taxes your annuity all those years ago, it didn’t change – and still hasn’t changed – the way that OPM actually pays your annuity. OPM still returns your own contributions first. Only when that money runs out will you begin receiving the government’s money. Since the amount you contributed will run out fairly quickly, probably within a few years, the tax-free portion of your spouse’s survivor annuity or the tax-free refund to your heirs will be far less than they might have expected after reviewing your federal income tax returns.

Sound like a classic flimflam to me. What do you think?