Military Retirement and VA Benefits in Retirement Planning

VA disability compensation

VA disability compensation is paid to veterans with a service-connected disability rating. Under 26 USC § 104(a)(4), it is fully excluded from federal income tax at every rating level, from 10% to 100%. Most states follow the federal treatment. The exclusion covers more than just income tax, though. VA disability is also excluded from:

• Social Security provisional income. The formula that determines how much of your SS benefit is taxable ignores VA disability entirely. It does not push you into the 50% or 85% taxable SS zone.
• IRMAA MAGI. Medicare uses your income from two years prior to set Part B and D premium surcharges. VA disability does not count toward that figure, regardless of the payment amount.
• ACA MAGI. The income figure used to calculate marketplace subsidy eligibility does not include VA disability, so it does not affect your position relative to the 400% FPL cliff.

This makes VA disability the cleanest income source in retirement. It adds to your spendable income without raising your tax bracket, affecting your Medicare premium tier, or making your Social Security more taxable. COLA adjustments to VA disability track the Social Security cost-of-living adjustment announced each fall.

Military retirement pay: federal and state tax treatment

Military retirement pay is taxed as ordinary income at the federal level, the same as a civilian pension. It stacks on top of Social Security, IRA withdrawals, and any other ordinary income. At the federal level, there is no special exclusion.

State treatment is a different story. As of 2026, more than 30 states provide a full or near-full exemption for military retirement pay:

State rules change. Partial exemptions often depend on age, years of service, disability status, or the date military service began. Verify your state's current rules each year. ThunderHarbor applies the state exemption automatically based on your state selection.

The Survivor Benefit Plan (SBP)

The Survivor Benefit Plan is an optional annuity program elected at retirement. If elected, the retiree pays a premium of 6.5% of the covered base amount (typically the full pension amount). Premiums are deducted from gross retirement pay before tax, which lowers the retiree's taxable income by the premium amount each year.

When the retiree dies and the surviving spouse begins receiving the SBP annuity, those payments are taxable as ordinary income. The survivor receives a 1099-R each year and owes federal income tax at their marginal rate. State tax depends on how the state treats surviving spouse income.

If the SBP annuity is the survivor's primary income source, they are likely in a lower bracket, which can make the taxation lighter than it was during the retiree's lifetime. The SBP election is locked at retirement, with only limited windows to change coverage later.

TRICARE coverage before Medicare

Military retirees under 65 are eligible for TRICARE rather than ACA marketplace coverage. The two main options are TRICARE Select (a preferred provider plan with cost-sharing for out-of-network care) and TRICARE Prime (an HMO-style plan with a small monthly premium and lower out-of-pocket costs).

Both are substantially cheaper than comparable ACA marketplace plans. This has two planning implications. First, the annual healthcare cost projection is significantly lower for military retirees than for civilians who need marketplace coverage. Second, because TRICARE beneficiaries are not eligible for ACA marketplace subsidies, there is no need to manage income below the ACA subsidy cliff (400% FPL). The ACA subsidy constraint that drives many pre-Medicare Roth conversion decisions simply does not apply.

The practical effect is that military retirees often have more bracket space available for Roth conversions in the pre-Medicare years, because the ACA cliff guard built into the optimizer does not need to activate.

TRICARE for Life at 65

When a military retiree or eligible dependent turns 65 and enrolls in Medicare Part A and Part B, they automatically become eligible for TRICARE for Life. TRICARE for Life acts as a wraparound supplement: Medicare pays first, and TRICARE for Life covers most of the remaining cost-sharing that Medicare does not cover. Out-of-pocket costs for most covered care drop to near zero.

There is no separate TRICARE for Life premium beyond the Medicare Part B premium. IRMAA surcharges still apply if income is above the threshold, because those are Part B surcharges, not TRICARE charges. High earners can still face IRMAA even with TRICARE for Life.

For planning purposes, TRICARE for Life effectively eliminates the out-of-pocket healthcare cost line in the projection for most covered care, while IRMAA remains a live variable for those with higher income.

How all three streams interact in a retirement projection

The combination creates a distinctive income structure. VA disability provides a base of tax-free, MAGI-neutral income. Military retirement pay provides ordinary income that is partially or fully state-exempt. TRICARE eliminates the ACA subsidy management question before Medicare starts. TRICARE for Life sharply reduces post-65 healthcare out-of-pocket costs.

For Roth conversion planning, the military retirement pay occupies bracket space that would otherwise be available for conversions. The optimizer accounts for this automatically: with a $40,000 pension filling the lower end of the 12% bracket, there may be only $24,000 of bracket space left before crossing into 22%, compared to $64,000 with no pension. The conversion pace slows, but VA disability adds income without touching MAGI, which partially offsets the reduced conversion headroom with cleaner tax-free cash flow.

The Tax Cliffs tab shows MAGI headroom against IRMAA thresholds and bracket boundaries year by year. The Roth Strategy tab shows the year-by-year conversion plan given all income sources combined.

How to enter military benefits in ThunderHarbor

All three streams have dedicated input fields under Income in your profile settings, in the Military / veterans benefits section:

• VA disability: enter your annual benefit amount and toggle COLA on. The projection treats it as fully tax-free and excludes it from all MAGI calculations automatically.
• Military retirement pay: enter as pension income. The projection applies your state's exemption rule based on your state of residence selection. The state tax line adjusts automatically.
• TRICARE: select TRICARE in the healthcare section. Pre-Medicare years use TRICARE Select or Prime cost estimates rather than ACA marketplace estimates. At 65, TRICARE for Life takes over alongside Medicare.
• SBP premium: if you elected SBP, toggle on the Survivor Benefit Plan option in the pension settings. The 6.5% premium reduces your taxable pension income and shows in the income breakdown.

Frequently asked questions