Simplifying Estimated Taxes in Retirement

While retirement simplifies life on many fronts, paying taxes isn’t always one of them. Many retirees find themselves saddled with the need to juggle withholding from several different sources – Social Security benefits, IRAs, pensions, and annuities to name a few. Often in addition, quarterly estimated tax payments are thrown into the mix to cover income sources where withholdings are not available. But for folks with IRAs who must take their annual required minimum distribution (RMD), here is a better solution for simplifying paying Uncle Sam.

Unless you need the money from your RMD to live on, you can wait until December to take your payout and ask your financial institution to withhold a big chunk of the RMD for the IRS. If your RMD is large enough to cover your entire tax bill, you can forego those pesky estimates AND the headaches involved in figuring how much to withhold from each income source and let the RMD make all of your tax payments in one lump sum. And the bonus is that your money keeps working for you for the other 11 ½ months of the year instead of portioning it out to IRS each quarter.

“What about the due dates on those estimates”, you ask? Normally estimated tax payments must be paid as you receive your income throughout the year, BUT amounts withheld from IRA distributions are considered paid evenly throughout the year, even if you receive a lump sum payment at the end of the year. This means there is no underpayment penalty for the one end-of-year payment!

One caveat is that this method may not work for state estimates, as some IRA sponsors won’t withhold state income taxes. Consult your IRA sponsor institution to find out if this will work for you, and ask your tax preparer if you need additional information.