Estimated Payments or Withholding in Retirement? Here's Some Guidance

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The United States income tax system operates on a pay-as-you-go basis, with taxes due periodically throughout the year as you receive income, even though you file a tax return only once each year. When you're working, your employer withholds income taxes from your paycheck and sends it to the IRS on your behalf. For most people, that takes care of the periodic payment requirement. But when you retire, it's generally up to you to make sure Uncle Sam gets his cut from your Social Security benefits and taxable retirement account distributions.

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You have two ways to satisfy the year-round tax payment obligation for retirement income. Taxes can be withheld from your benefits and distributions, or you can make estimated tax payments to the IRS. You can mix and match if you want, but just make sure you pay enough during the year to avoid an IRS underpayment penalty. There's no penalty if you owe less than $1,000 in tax when you file your return. You'll also avoid the penalty if your withholding and estimated tax payments equal at least 90% of your tax liability for the year, 100% of the tax shown on your tax return for the previous year, or 110% of the tax shown on the previous year's return if your adjusted gross income for that year was more than $150,000.

Withholding on Retirement Income

If you receive periodic payments from a 401(k) plan, pension or traditional IRA, income taxes are automatically withheld from those payments as if they were wages. (Periodic payments are made at regular intervals for at least one year.) You can, however, adjust the amount of tax that is withheld, or cut off withholding altogether, by completing IRS Form W-4P and giving it to the payer. But you generally can't request zero withholding for payments sent outside the U.S. and its territories.

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For nonperiodic payments from pensions or retirement accounts, 10% is automatically withheld from the taxable portion of the payment unless you request a different percentage using Form W-4R. (Again, give it to the plan, pension or IRA custodian.) Withholding generally can't dip below 10% for nonperiodic payments sent abroad.

There's a special rule for 401(k) or pension plan distributions paid directly to you if the payment is eligible for a tax-free rollover to an IRA or other eligible retirement plan. In that case, the plan administrator must withhold a flat 20% for taxes. You can avoid the 20% withholding by having the money sent directly to the rollover IRA or another eligible account. Taxes won't be withheld from Roth account distributions because those payments aren't taxable.

When it comes to Social Security benefits, there's no automatic withholding. Instead, you must request withholding at a rate of 7%, 10%, 12% or 22% by filing Form W-4V if you want taxes paid upfront. But, again, don't send the form to the IRS. Instead, mail it to your local Social Security office.

Paying Estimated Taxes

You can also pay estimated taxes directly to the IRS on a quarterly basis using Form 1040-ES. For the 2022 tax year, the first three payments are due April 18, June 15 and Sept. 15 of this year. The fourth payment is due Jan. 17, 2023. No final payment is needed if you file your 2022 tax return by Jan. 31, 2023, and pay the entire balance due with your return.

A worksheet in the instructions for Form 1040-ES can help you calculate the amount of your estimated payments. If your original estimate is too high or too low, simply submit another Form 1040-ES to readjust later payments. You should also recalculate the payment amount if your financial situation changes -- or the tax law does -- and it affects your tax liability for the year.

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The IRS gives you many ways to pay estimated taxes: check, cash, money order, credit card or debit card. There are several online payment options, too. For details, check the instructions for Form 1040-ES.

Paying State Taxes in Retirement

Your state may want to collect taxes throughout the year, too. Check with your state's tax agency to learn about its withholding and estimated tax payment requirements. Although some plan administrators and IRA custodians may be able to withhold state taxes for you, Social Security won't give you that option.

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Rocky Mengle was a Senior Tax Editor for Kiplinger from October 2018 to January 2023 with more than 20 years of experience covering federal and state tax developments. Before coming to Kiplinger, Rocky worked for Wolters Kluwer Tax & Accounting, and Kleinrock Publishing, where he provided breaking news and guidance for CPAs, tax attorneys, and other tax professionals. He has also been quoted as an expert by USA Today, Forbes, U.S. News & World Report, Reuters, Accounting Today, and other media outlets. Rocky holds a law degree from the University of Connecticut and a B.A. in History from Salisbury University.