So, you’re done with your 2016 tax return? Congratulations. Now get back on the taxpayer treadmill. It’s time to work on your Form 1040-ES to pay estimated 2017 taxes. The first quarterly payment is due April 18, the same day as your 2016 return.
If you’re still working, you probably don’t need the 1040-ES. Withholding on your paychecks should ensure compliance with the tax system’s pay-as-you-earn demands. But if you’re retired, chances are you need to make estimated payments. Don’t assume payments are due every three months. For 2017, the payment deadlines are April 18, June 15, September 15 and January 16, 2018. You’re basically supposed to figure how much tax you’ll owe for 2017 and send it along to the IRS in four equal installments.
Pay at least 90% of your 2017 liability or 100% of what you owed for 2016, and you will have done your duty and be protected from an underpayment penalty. (That 100% of last year’s taxes rises to 110% if your 2016 adjusted gross income was more than $150,000.)
Not only can making those estimates be a pain, writing those checks can disrupt your cash flow. Many taxpayers simply divide the previous year’s tax bill by four and send 25% on each payment date to wrap themselves in the “100% of last year’s tax bill” exception.
But depending on the source of your retirement income, you may be able to satisfy the IRS via withholding from those payments. Unlike withholding from paychecks, withholding from retirement income is almost always voluntary. (The exception: Nonperiodic payouts from company retirement plans, including lump sums, are hit with 20% withholding for the IRS.)
If you want federal taxes withheld from Social Security benefits, you must file Form W-4V (“V” is for voluntary) with the Social Security Administration. You can ask that 7%, 10%, 15% or 25% of each monthly benefit be carved off for the IRS. When it comes to pension or annuity payments, you control how much will be withheld by filing a Form W-4P with the payor. The worksheet for the form is similar to the one that Form W-4 employees use to set withholding from wages.
For IRA distributions, the law requires that 10% be withheld for the IRS unless you tell the custodian otherwise. You can block withholding altogether or ask that as much as 100% be withheld.
A Better Way
Speaking of IRAs, a little-known opportunity may free you from withholding on multiple income sources and from the hassle of filing estimated taxes. We call it the RMD solution.
Starting at age 70½, retirees must take required minimum distributions from their traditional IRAs, based on the balance in the accounts on the previous December 31 divided by a factor provided by the IRS.
If you don’t need the money to live on, wait until December to take your RMD and ask the sponsor to withhold a big chunk for the IRS, 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 made in a lump sum payment at year-end.
So if your RMD is large enough to cover your entire tax bill, you can keep your cash safely ensconced in the IRA most of the year, avoid withholding on other sources of retirement income, skip quarterly estimated payments . . . and still avoid the underpayment penalty.
That’s exactly what Retirement Report subscribers Neil and Liz Ferrari of Wilmette, Ill., plan to do starting this year. “We have two pensions, two Social Security benefits, usually capital gains and now RMDs,” says Neil. “Using your RMD solution will save us tons of paperwork and improve our cash flow for years.”
Note that RMD withholding might not work when it comes to state estimated taxes because some IRA sponsors won’t withhold state income taxes. Vanguard, for example, only withholds for 24 states. Check this point with your IRA sponsor.