We do love it when someone refers a family member or friend to us. Sometimes the question is, “How can we introduce them to you?” Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.
Here are this week’s items:
Portfolio Update: Murs and I have recorded our portfolio update for September 9, 2024
Retirement Tax Withholding – Tips for Avoiding Tax Surprises
Radon and Murs discuss the importance of understanding tax withholdings in retirement to avoid tax surprises. To help navigate this complex terrain, they bring in Taylor Wolverton, a Certified Financial Planner and Enrolled Agent specializing in tax strategy.
Retirement Tax Withholding – Tips for Avoiding Tax Surprises
Navigating the complexities of tax withholding in retirement can feel like venturing into uncharted territory. During your working years, taxes are often a distant concern. Employers handle withholding from each paycheck, ensuring that the process remains smooth and largely invisible to the employee. However, retirement changes this dynamic entirely…
Navigating the complexities of tax withholding in retirement can feel like venturing into uncharted territory. During your working years, taxes are often a distant concern. Employers handle withholding from each paycheck, ensuring that the process remains smooth and largely invisible to the employee. However, retirement changes this dynamic entirely. Suddenly, there are no regular paychecks with taxes already deducted, and you must actively manage your tax withholding to avoid any unpleasant surprises come tax time.
Imagine expecting a comfortable, worry-free retirement only to find yourself facing a hefty tax bill or a confusing tax scenario that catches you off guard. Such surprises can disrupt your financial peace and leave you scrambling for solutions. The key to avoiding this predicament lies in understanding and proactively managing your tax withholding in retirement. In this blog, we’ll explore various tips and strategies to help you steer clear of tax surprises, ensuring that your retirement is as financially secure and stress-free as you envisioned.
Understanding Retirement Tax Withholding
For many, transitioning from a regular paycheck to retirement income requires a fundamental shift in thinking about taxes. During your career, tax withholding from your salary is automatic, making tax planning seem effortless. However, when you retire, various income sources, such as Social Security, pensions, annuities, and investments, must be managed for tax purposes. Understanding retirement tax withholding is crucial to avoid either overpaying taxes throughout the year or facing a substantial tax bill when filing your return.
The Role of a Financial Planner
To navigate this complexity, financial advisors like Taylor Wolverton, a CERTIFIED FINANCIAL PLANNER™ and an Enrolled Agent (EA) specializing in tax strategy, recommend conducting regular reviews of your tax withholding status. By understanding your different income sources and their tax implications, you can better estimate your annual tax liability and adjust your withholding accordingly. This proactive approach helps ensure you’re neither overpaying nor underpaying, giving you peace of mind.
Common Income Sources in Retirement and Their Tax Implications
Retirement income often comes from various sources, each with unique tax treatment:
Social Security Benefits: Up to 85% of Social Security benefits may be taxable, depending on your overall income level. It is essential to decide whether to have taxes withheld from these payments or to pay estimated taxes quarterly.
Pensions and Annuities: These are typically taxable as ordinary income. If you have a pension or annuity, you should consider setting up automatic tax withholding to avoid a large bill at tax time.
IRA and 401(k) Withdrawals: Withdrawals from traditional IRAs and 401(k) plans are subject to ordinary income tax. You can elect to have taxes withheld from these distributions to avoid owing a large sum when filing your return.
Investment Income: Interest, dividends, and capital gains are also taxed, often at different rates. Understanding the tax treatment of your investments is key to managing your overall tax liability.
The Importance of Tax Strategy Meetings
A regular tax strategy meeting can help retirees better understand their current tax situation and anticipate future changes. In these meetings, financial planners like Taylor Wolverton review income sources, evaluate tax brackets, and adjust withholdings to align with financial goals. For example, Taylor conducted over 85 tax strategy meetings last year, helping clients optimize their withholding strategies to avoid surprises.
Case Study: John and Jane’s Social Security Withholding Strategy
Consider the case of John and Jane, who retired a few years ago and have been living primarily on savings. This year, they decided to start their Social Security benefits, prompting a reassessment of their tax situation. Their combined Social Security income amounts to $55,000, with 63% taxable due to their other income sources.
To avoid a significant tax bill, Taylor recommended setting withholding rates of 12% for John and 7% for Jane on their Social Security benefits. This strategy ensures that they withhold sufficient tax throughout the year, resulting in a manageable tax liability when they file their return.
How to Adjust Your Tax Withholding
Adjusting your tax withholding is a critical component of effective retirement tax planning. Here are some steps to consider:
Evaluate Your Income Sources: Review all potential income sources, including Social Security, pensions, investments, and required minimum distributions (RMDs) from retirement accounts.
Estimate Your Taxable Income: Calculate your expected taxable income for the year. Be sure to consider both ordinary income and capital gains, as well as any deductions or credits you may be eligible for.
Use the IRS Tax Withholding Estimator: The IRS provides an online tool to help taxpayers estimate their tax liability and adjust withholding accordingly. This can be particularly useful for retirees with multiple income sources.
Adjust Withholding on Social Security Benefits: Social Security allows you to withhold at rates of 7%, 10%, 12%, or 22%. Choose a rate that aligns with your estimated tax liability to avoid surprises.
Consider Quarterly Estimated Taxes: If you have significant investment income or other sources of taxable income that do not withhold taxes, you may need to make quarterly estimated tax payments to avoid penalties.
Why are Regular Reviews Essential?
Income needs and sources can change annually, especially in retirement. Regular reviews ensure that your tax withholding remains appropriate for your current situation. For instance, if you sell a major asset, like real estate or stocks, you may face a large capital gain that changes your tax bracket. Similarly, changes in Social Security benefits or required minimum distributions (RMDs) can alter your taxable income.
Case Study: Bob and Sue Adjust Their Withholding
Bob and Sue, both aged 71, have a different scenario. With Bob’s first full year of retirement, they need to adjust their withholding to reflect their lower taxable income. They prefer receiving a small refund, around $2,000, rather than a large one. Taylor recommended reducing their Social Security withholding from 22% to 12% for Bob and 7% for Sue, aligning with their lower income bracket.
By making these adjustments, Bob and Sue managed to reduce their tax withholding while still securing a small refund, thereby improving their cash flow throughout the year.
Tax Withholding Tips for a Smooth Retirement
Here are some additional tax withholding tips to help you avoid surprises in retirement:
Stay Informed: Keep up with any changes to tax laws that may affect your retirement income.
Review Regularly: Conduct annual reviews of your tax situation to adjust withholding as needed.
Consider a Professional: Engage with a financial planner or tax professional who understands retirement tax strategy to help guide your decisions.
Plan for Large Expenses: If you anticipate large medical expenses or charitable contributions, these can impact your tax liability and withholding needs.
Conclusion
Understanding and managing your tax withholding in retirement is essential to maintaining financial stability and avoiding unwanted surprises. By proactively adjusting your withholding and engaging in regular tax strategy meetings, you can ensure a smooth transition into retirement and enjoy peace of mind.
If you want to understand all this a little better, we offer a complimentary phone call that you can schedule with us on our website. If we can’t answer all your questions in just 15 minutes, we’ll guide you to the next steps to find the answers you need.
Schedule your complimentary call with us to learn more about Retirement Tax Withholding – Tips for Avoiding Tax Surprises.
We do love it when someone refers a family member or friend to us. Sometimes the question is, “How can we introduce them to you?” Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.
Here are this week’s items:
Portfolio Update: Murs and I have recorded our portfolio update for March 25, 2024
In this Episode of the Secure Your Retirement Podcast, Radon, Murs, and Taylor discuss navigating tax withholding for retirees. When you retire, you have various sources of income, and you can choose to either withhold the tax on them, make estimated tax payments throughout the year, or do a combination of both.
While you’re working and earning a salary, your employer handles tax withholdings. When you retire and transition to multiple sources of income, it’s worth reviewing your tax situation to be sure you’re withholding enough to avoid any surprise payments and/or penalties due at the time you file your return.
Taylor Wolverton joined us on our podcast this week, and for those who don’t know, she’s our go-to person for everything taxes. This week we’re discussing tax withholding, which can change considerably when you retire.
While you’re working and earning a salary, your employer handles tax withholdings. When you retire and transition to multiple sources of income, it’s worth reviewing your tax situation to be sure you’re withholding enough to avoid any surprise payments and/or penalties due at the time you file your return.
What is Withholding vs Estimated Tax Payment?
There are two main ways to pay taxes (you can do a combination of both) which include:
Withholding from income sources
Making estimated tax payments
For our first method, taxes can be withheld from pensions, social security, IRA distributions, etc. Once you have your withholdings set up properly, this option requires the least amount of effort to maintain.
Estimated tax payments are another option and are due quarterly. At the time your tax return is filed, it’s common for your CPA / tax preparer to help you estimate how much you’ll need to pay every quarter with vouchers listing the amount to pay and when you need to pay it. You can go to IRS.gov and your state government website to make your quarterly payments.
The payment due dates are not even quarters and are:
April 15th (for tax due on income received January 1 – March 31)
June 15th (for tax due on income received April 1 – May 31)
September 15th (for tax due on income received June 1 – August 31)
January 15th (for tax due on income received September 1 – December 31)
The IRS requires taxpayers to ‘pay as you go.’ For example, if you sell highly appreciated stock before the end of March, the IRS requires that you make an estimated tax payment for the tax due on that sale of stock by April 15th of the same year. If you sold the stock during the month of November, your estimated tax payment would be due by January 15th of the following year. The potential consequence of not making estimated tax payments on time is underpayment penalties from the IRS which will be determined and reported on your tax return once it has been filed.
What You Need to Think About: Social Security
Social Security is something we review with our clients annually. You might receive your benefits immediately and your spouse years from now, so there may be a transition period for some families to consider.
The default withholding amount on Social Security is 0%. If you don’t make an election to have federal taxes withheld from social security, you may need to pay quarterly taxes on the income. We have an entire episode on taxation of social security benefits (listen to the podcast or read the blog post) if you’re interested.
Most benefits will be taxable on the federal level, but each state varies on whether they will tax social security benefits or not. The state of North Carolina does not tax social security.
If you want to withhold taxes from your Social Security, you can Google “form W-4V” or go to the IRS site (here). It’s an easy form to fill out and will allow you to start withholding taxes, with options for:
7%
10%
12%
22%
Once you fill out the form and submit it to the social security administration office, taxes will automatically be withheld. If you want to stop withholding taxes, you’ll fill out the same form again but ask for the withholding to stop.
It is not possible to withhold state tax on social security.
What You Need to Think About: Pension Income
Not everyone will have a pension, but if you do and want to begin withholding taxes from your pension, you’ll need to fill out Form W-4P. You’ll often receive the form from where your pension is coming from, such as the government or a union, but you can also find it publicly available online.
Unfortunately, the form is not as straightforward as the social security withholding form, and it’s more of a guide to approximate withholding taxes.
An IRA is an interesting form of income because you contribute to your IRA for so long, and then in retirement, may begin withdrawals to cover expenses, and/or be forced to withdraw through required minimum distributions (RMD).
Clients turning 73 begin RMDs for the first time and will owe federal and state tax on those distributions. The amount of the RMD, the associated tax liability, and appropriate rate for withholding is a conversation we often have with clients.
If you’re starting recurring monthly distributions from an annuity, the most common default federal tax withholding is 10%. You can fill out Form W-4R to withhold an amount other than 10% or not withhold taxes at all.
What You Need to Think About: Income Not Eligible for Withholding
Some forms of income are not eligible for withholding. Some of these sources of income include interest (from a money market account, CD, checking account, and/or savings accounts) dividends, capital gains, sale of property, rental income, self-employment income, royalties, alimony, etc.
For a one-off income event such as the sale of property or sale of highly appreciated stock, you may consider making a one-time estimated tax payment.
However, if you have income not subject to withholding that recurs more regularly such as self-employment or rental income, you want to consider paying quarterly taxes before each due date during the year.
To review your situation in-depth and determine whether any adjustments to withholdings are needed, you will need to review all sources of income, determine the annual dollar amounts expected to be received, and review all current tax withholdings.
Every client’s goal is different. You may want a refund every year, or you might prefer to make a payment at the time your tax return is filed.
Your financial professional can help you set this up properly to align with your goals.
If you’re unsure about taxes in retirement, just reached retirement, or want to adjust your withholdings so that you’re not hit with a surprise tax bill, feel free to give us a call and we’ll be more than happy to help you through this process.
