Life is Short: Simplify Paying Your Taxes in Retirement

May 08, 2019
By W. Kirk Taylor, CFP®

So, you made it. Retirement. The final frontier. You’ve been working (literally) for this your entire career and now you get to slow down and enjoy this stage of your life. Regardless of all your planning for this, you may be surprised to discover that you miss the camaraderie of the workplace. Or worse, you experience too much “we” time at home with your spouse or significant other. As a client once said to me, “my wife married me for richer or poorer, but apparently not for lunch!”

Now that you have time on your hands, another surprise that awaits you is the complexity and hassle of paying estimated taxes. To meet the IRS’s pay-as-you-go rules on your income, you need to make estimated tax payments in April, June, September and January on sources of income such as Social Security, pension payments and investment income from interest and dividends.

The IRS requires that you estimate and pay at least 90% of your current year tax liability or that you pay 100% of last year’s tax liability. There’s an exception though; if your prior-year adjusted gross income exceeded $150,000, you have to pay 110% of last year’s tax bill in the current year.To pay your estimated taxes, send a check along with Form 1040-ES to the IRS. Or you can send payments securely online through Direct Pay or the Electronic Federal Tax Payment System.

Figuring your tax liability accurately at the start of the year can be a challenge, especially when it comes to estimating capital gains from your portfolio, or year-end distributions from mutual funds. Doing so requires regular monitoring of dividends, interest and capital gains. To help simplify the process (well, sort of), the IRS kindly provides taxpayers with a worksheet.

Note that there is a fine line between overpaying your taxes and receiving a large refund. There is also a fine line between underpaying your tax liability and being forced to write a large check come April 15th. Precision is needed if you wish to avoid the greater of these two evils.

Luckily, there are a few strategies you can harness to simplify paying taxes in retirement. We believe that the easiest method is to withhold taxes from payments such as Social Security, pensions, annuities and distributions from your IRA – much like withholding taxes from your paycheck. 

To withhold taxes from your Social Security payments, file Form W-4V with the Social Security Administration and select from one of four levels of withholding: 7%, 10%, 12% or 22%. To withhold taxes from pension or annuity payments, file Form W-4P with the payer. And, if you are taking distributions from your IRA, you can instruct your custodian to withhold taxes as well.

There is one final twist if you are 70½ or older and subject to taking a Required Minimum Distribution (RMD). If you don’t need your RMD to meet spending needs throughout the year, and your RMD meets or exceeds your estimated tax bill, you may direct your IRA custodian to send all or a portion of the RMD directly to the IRS at year-end.

Going this route allows you to enjoy a full year of tax-deferred growth before taking your RMD and simultaneously satisfies the IRS’s four-installment payment requirement. This is due to the fact that the IRS considers taxes withheld from IRA distributions as having been paid evenly throughout the year, even if the taxes were withheld on the last day of the year.

In retirement, sometimes less is more. When it comes to the hassle of sending a check to the IRS four times a year, consider the tips above and instead spend more time on the golf course, volunteering, traveling or spending time with friends and loved ones. 

Meet W. Kirk Taylor, CFP®.

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To view other articles in the May 2019 Financial Planning Focus newsletter, click here.


Important Disclosures

West Financial Services, Inc. is an SEC registered investment adviser. Registration does not imply a certain level of skill or training.

Information contained herein was derived from third party sources including, but not limited to, Bloomberg, Standard & Poor’s, Dow Jones & Company, the Federal Reserve Bank of New York, and Morningstar, Inc. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. We have not and will not independently verify this information. Please contact us if you would like to obtain a copy of the third party sources.