Advertisement
taxes

The RMD Solution to the Hassle of Filing Estimated Taxes in Retirement

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.

Congratulation if you're done with your 2019 tax return. But you're not quite done with taxes yet for the year. You still have to work on your Form 1040-ES to pay estimated 2020 taxes. Thanks to the coronavirus crisis, the first quarterly payment is now due July 15 instead of April 15, which is the normal due date.

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. You're basically supposed to figure how much tax you'll owe for 2020 and send it along to the IRS in four equal installments.

Advertisement - Article continues below

Pay at least 90% of your 2020 liability or 100% of what you owed for 2019, 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 2019 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: Non-IRA distributions that can be rolled over tax-free to an IRA or other eligible retirement plan are generally subject to mandatory 20% withholding.)

Advertisement
Advertisement - Article continues below
Advertisement - Article continues below

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%, 12% or 22% 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.

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 72, 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. (Note: Before the SECURE Act, which was signed into law on December 20, 2019, RMDs were required starting at age 70½.)

Advertisement - Article continues below

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.

Note that RMD withholding might not work when it comes to state estimated taxes because some IRA sponsors won't withhold state income taxes. Check this point with your IRA sponsor.

Advertisement

Most Popular

HSAs Get Even Better
Financial Planning

HSAs Get Even Better

Workers have more options with flexible spending accounts, too.
July 2, 2020
Find a Great Place to Retire
happy retirement

Find a Great Place to Retire

Our cities provide plenty of space to spread out without skimping on health care or other amenities.
July 2, 2020
What Are the Income Tax Brackets for 2020 vs. 2019?
tax brackets

What Are the Income Tax Brackets for 2020 vs. 2019?

The IRS unveiled the 2020 tax brackets, and it's never too early to start planning to minimize your future tax bill.
June 20, 2020

Recommended

20 IRS Audit Red Flags
tax returns

20 IRS Audit Red Flags

There's no sure way to avoid an IRS audit, but these red flags could increase your chances of drawing unwanted attention from the IRS.
July 1, 2020
10 IRS Audit Red Flags for Retirees
retirement

10 IRS Audit Red Flags for Retirees

Watch out: These things can increase the chances that the IRS will give your tax return a closer look.
July 1, 2020
10 Tax Breaks for the Middle Class
tax deductions

10 Tax Breaks for the Middle Class

Tax breaks aren't just for the rich. There are plenty of them that are only available to middle- and low-income Americans.
June 30, 2020
Stay on Top of RMD Rule Changes for 2020
required minimum distributions (RMDs)

Stay on Top of RMD Rule Changes for 2020

Between the SECURE Act and the CARES Act, the landscape has changed for RMDs this year. You don’t need to take one, for instance. And if you already h…
June 29, 2020