When you were working, paying all your taxes was not that big a deal (even though it was painful). You set your withholding, the taxes came out of your check and hopefully you and the IRS were pretty close on the numbers by the end of the year.
But if you’re retired, chances are good that you have to file quarterly estimated taxes. Since there’s no paycheck from which to withhold taxes, the IRS wants you to figure out how much tax you owe for the year and then send it along to them in four equal quarterly payments. The IRS pay-as-you-earn system is still in place even though you’re no longer working. By the end of the year, pay 90% of your current year taxes or 100% of your previous year tax bill and you escape the underpayment penalty. The problem with retirees paying quarterly taxes is the possibility of interrupting cash flow.
But depending on the sources of your retirement income, you may be able to satisfy the IRS by having taxes withheld when you receive distributions. For example:
- An IRA distribution paid to you is subject to 10% withholding unless you opt out of withholding or choose to have a different amount withheld.
- The IRS requires 20% to be withheld for taxes when you take a distribution from your 401(k).
- For pension and annuity payments, the IRS says, “For withholding purposes, these payments generally are treated as if they were wages, see Tax Withholding Types. A payer can figure withholding by using the payee’s Form W-4P, Withholding Certificate for Periodic Pension or Annuity Payments, and the applicable tables and methods in Publication 15‑T, Federal Income Tax Withholding Methods.”
You can even voluntarily have taxes withheld from your Social Security benefit by filing IRS form W4V, the Voluntary Withholding Request. You can ask for 7 percent, 10 percent, 12 percent or 22 percent be withheld. Those are the only choices.
Once withholding is set up on your Social Security payment, the decision is not chiseled in stone. If you find out later that withholding isn’t necessary to keep you in the good graces of the IRS simply submit a new W4V revoking the withholding option.
However…
There is another way for retirees who have reached the magical age of 73 and are forced by the IRS to take required minimum distributions from their IRA. If you don’t need the money to live on, wait until December to take your RMD and ask the sponsor to withhold enough to cover your estimated tax on the IRA payout and all of your other taxable income for the year.
Although estimated tax payments are considered made when you send in the checks—and must be paid as you receive your income during the year–amounts withheld from IRA distributions are considered paid evenly throughout the year, even if you take a lump sum payment at the end of the year.
So, if your RMD is large enough to cover your entire tax bill, you can keep your funds in the IRA working for you, avoid withholding on other sources of retirement income, skip quarterly estimated payments and still avoid the underpayment penalty.
Disclaimer
This information is presented for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy any investment products. None of the information herein constitutes an investment recommendation, investment advice or an investment outlook. The opinions and conclusions contained in this report are those of the individual expressing those opinions. This information is non-tailored, non-specific information presented without regard for individual investment preferences or risk parameters. Some investments are not suitable for all investors, all investments entail risk and there can be no assurance that any investment strategy will be successful. This information is based on sources believed to be reliable and Alhambra is not responsible for errors, inaccuracies, or omissions of information. For more information contact Alhambra Investment Partners at 1-888-777-0970 or email us at [email protected].
