Most retired public safety officers qualify for a $3,000 annual tax exclusion on healthcare premiums. Here’s what it is, how SECURE Act 2.0 made it easier to claim, and what to do if you’ve been missing it.
By Courtney Hoffman, CFP®, AAMS™ EverPar Advisors
If you’re a retired public safety officer, there’s a federal tax benefit sitting in the Internal Revenue Code that was written specifically for you. A lot of officers have never heard of it, and a fair number who have heard of it aren’t claiming it correctly.
I recently sat down with Ken Petrashek, CFP® to walk through some of the most common questions we’ve been getting since the SB102 campaign, and this topic kept coming up. So we put together a full video on it, and this post covers the key points for anyone who wants it in writing.
What the PSO Exclusion Is
The PSO exclusion was created under the Pension Protection Act of 2006 and lives in Section 402(l) of the Internal Revenue Code. It allows eligible retired public safety officers to exclude up to $3,000 per year from their gross income, as long as that amount goes toward qualified health insurance premiums.
This applies to retired law enforcement officers, firefighters, and other public safety personnel covered under a governmental pension plan. It is not limited to OPPRS members. If you retired from any qualifying public safety position anywhere in the country, this likely applies to you.
The dollar amount on its own is not life-changing. At a 22% federal tax bracket, $3,000 excluded saves you around $660 in federal taxes for the year. But across a 25-year retirement, that compounds to roughly $16,500, and it stacks with other planning decisions in ways that matter.
One other thing worth noting: the Fraternal Order of Police is currently lobbying Congress to raise that ceiling from $3,000 to $6,000. Nothing is guaranteed, but if that change happens it would be a significant benefit for retired officers and their families.
How SECURE Act 2.0 Changed the Rules
Under the original 2006 legislation, claiming the exclusion required your pension system to pay your insurance premiums directly to the carrier. That created a significant administrative burden for pension boards, and a lot of officers either gave up on the process or never knew it was available to them.
SECURE Act 2.0, passed at the end of 2022, removed that requirement. Under the updated rules, you can pay your premiums yourself and still claim the exclusion when you file your taxes at year end. Both paths now work, direct billing through your pension or self-pay and reconcile at tax time. This change meaningfully reduced the friction for officers trying to use the benefit, and most people haven’t heard about it yet.
How to Claim It on Your Tax Return
This is where a lot of returns go wrong, even with a competent preparer involved.
When you file, you will receive a 1099-R showing your gross pension distribution for the year. Here is how the exclusion gets applied on your 1040:
Line 5A is where you report the full gross distribution. If you received $50,000 in pension distributions, that full $50,000 goes on line 5A.
Line 5B is where you report the taxable amount. You subtract the qualified premium amount, up to $3,000, and report the reduced figure there. In the same example, that would be $47,000 on line 5B.
The letters PSO must appear next to line 5B. That stands for Public Safety Officer, and it is the signal to the IRS that you are claiming this exclusion. Tax software will generally walk you through this, but a fair number of CPAs will miss it if you don’t bring it up directly. If someone else is filing your return, make sure they know about this before they file.
On the documentation side, you do not need to attach proof to your return, but you should keep it on file in case of an audit. That means premium receipts, explanations of benefits from your insurer, and a copy of your 1099-R for the year. Think of it similarly to how you would document an HSA.
What Counts as a Qualified Premium
The range of qualifying coverage is broader than most people expect. The following all count:
- Accident or health insurance
- Qualified long-term care insurance
- Medicare Part B and Part D
- Premiums through your department’s retiree plan
- ACA Marketplace policies
- A spouse’s employer group plan, if you are covered under it
- COBRA coverage
Coverage can be for you, your spouse, or your dependents.
One important exception: Medigap premiums, also known as Medicare Supplement premiums, do not qualify. If that is your only coverage, the exclusion would not apply to those specific costs.
The DROP Withdrawal Trap Most Officers Don’t See Coming
This is a planning issue that comes up frequently and deserves its own mention.
When you take a large distribution from your DROP account, that amount is taxable in the year you receive it. A large enough withdrawal can push your income into a higher tax bracket for that year, which is something most people are aware of going in.
What catches people off guard is the IRMAA bracket. IRMAA stands for Income Related Monthly Adjustment Amount, and it determines how much you pay for Medicare Part B and Part D premiums. The way it works is that Medicare looks back two years at your income to set your premium amount. So if you take a large DROP distribution today, you may not feel the impact until two years from now when your Medicare premiums come in significantly higher than expected.
The way to handle this is through coordinated planning. You may not be able to avoid it entirely, but if you know it is coming you can plan around it and set aside what you need ahead of time. The problem compounds when the planning is not done ahead of the distribution.
When to Start the Planning Process
We recommend starting six to twelve months before your anticipated retirement date. That gives us enough runway to look at your retirement date, your DROP distribution timing, your healthcare bridge strategy, and your tax situation as one coordinated plan rather than a series of separate decisions made at the last minute.
If you are already retired and are not sure whether you have been claiming the PSO exclusion, go back and look at your last few tax returns. Check line 5B on your 1040. If PSO is not listed there and you were paying qualified premiums, you may be able to amend those returns and recover what you missed. The standard amendment window is three years.
The planning window is genuinely wide before retirement. It gets narrow quickly once you are past it. If you have questions about any of this or want to walk through your specific situation, reach out to our team at everpar.com. We would be glad to help.
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