The IRS says:
"If you retired on disability, the disability annuity
you receive from the CSRS or FERS is taxable as wages until you reach
minimum retirement age, as explained in this section.
However, beginning on the day after you reach minimum retirement age, your payments
are treated as a retirement annuity and you can begin to recover the
cost of your annuity under the rules discussed in Part II, Rules for
Retirees" [in IRS
Publication 721].
If your annuity began after November 19, 1996, then
the taxable amount of your retirement annuity is determined by the Simplified
Method as described on pages 6 and 7 in IRS Publication 721.
In general, this Simplified Method takes the amount of "cost"
you have in the annuity ("cost" = after-tax dollars you contributed
to the plan over the years), and spreads it over a number of payments based
on your (and your survivor beneficiary’s, if one) estimated life spans, so that
in each monthly payment, part of the payment is taxable and part is not
taxable (the latter being the allocated amount of the return of your
"cost" or contribution).
If your annuity began before November 19, 1996, then please see "Part II
Rules for Retirees" in IRS
Publication 721.
