Using IRAs To Reduce Estimated Tax Penalties

Retirement Starts Today

The episode explores strategic methods for retirees to manage and avoid IRS estimated tax penalties through clever use of IRA distributions.

Key takeaways

• Withholding from IRA distributions is treated by the IRS as being paid evenly throughout the year, unlike estimated payments.
• The safe harbor rule allows retirees to avoid penalties by paying 100% of last year's tax bill or 110% if income exceeds $150,000.

Main topics

• Estimated tax penalty avoidance
• IRA withholding strategies

Notable quotes

Withholding counts as if it were paid evenly across the entire year, no matter when it comes out.

Conclusion

This episode provides practical tax-mitigation tactics for retirees lo

Transcript preview

Speaker 2 (0:06) Welcome back to Retirement Starts Today. I am your humble host as always, Benjamin Brandt. If you're new to the channel, this is where you can learn how to spend more money and pay less taxes on your way to an even better retirement. This week's retirement headline is a bit of a throwback to 2020. There was a Kitsis article that I really liked, and they're outlining a tax rule that lets a retiree pay their entire year's tax bill in December and have the IRS treat it as though it was paid on time all year long. It's a rule that we lean on a lot for year-end tax planning and Roth conversion. So I'm going to walk you through how we use it, and maybe you can possibly use it for your year-end tax planning or with your advisor. Then we move on to a listener question from Leah. She had a windfall of income in December, and it cost her more than $18,000 in taxes the following April. And she wants to know if she's stuck paying those taxes and a similar quarterly estimate based on those taxes for the following year. actually shares a lot with our retirement headlines. So those are good compatriots there. And then as we always do, we will end with our retire to something segment. We're going to hear from Mike in Iowa who retired into church leadership and mission trips and says that the work that used to get squeezed into evenings and weekends is now the center point of his week and he loves it. So we're going to get into all that and more right after these retirement headlines. So normally our retirement headlines are somewhat new based on new articles, new publications. We're going back in time a little bit this week. We're going back to Michael Kitsis' blog from 2020. And as we're gearing up in our office for year-end tax planning that usually starts sometime in mid-October and goes to Thanksgiving, this is something we cover quite a bit in those meetings. The title is a bit of a mouthful. It's using retirement accounts to reduce estimated tax penalties via tax withholding from required minimum distributions, authored by Jeff Levine. Now the reason that taxes change in retirement versus when we're working just has a lot to do with us living off of our portfolio. So most people working a job, they never really think about estimated taxes because their employer withholds them from every paycheck. You dial in your withholding once, and as long as you're not paying it a bunch at the end of the year or receiving a refund that is bigger than you'd like, most of us don't really give it a second thought after we dial it in. Then, of course, you retire, that paycheck goes away, and now your income comes from something like IRAs, dividends, capital gains, maybe a pension, Social Security, maybe one, maybe all five, maybe they start and stop. All of those generate taxes. All of them generally have their own method of accounting for and or withholding taxes, none of which are mandatory. So it gets significantly more complicated. In fact, we could have a situation where we just don't withhold from Social Security and we don't withhold from our pension and we account for all of the taxes from our pension and Social Security just from IRA distributions. We have had some people that don't withhold from capital gains and IRAs and they do a supersized withholding from Social Security because they want that to be coming from someone else's money. It can get more complicated from there, but people have different preferences. And at the end of the day, at the end of the year, we've got to settle up on all of that. And the proposed remedy from the IRS when you're retired is send in quarterly estimated payments. So whatever your tax bill was last year, cut it into four pieces and send it in on time. Now, if you don't do that, or if you send in too little, that's when we get hit with what's called the estimated tax penalty. The first point that I liked in the article was the word penalty. Penalty is maybe a little bit heavy handed. In my view, it's just interest. The rate is the federal short-term rate plus 3%. Now in 2020, when this article was written, it was about 3.25%. Not bad. In fact, maybe you even beat that in your money market account. Today it's 7%, so it's not nothing, but it's not exactly the IRS kicking down your door with a SWAT fan in the driveway. The second point is how to avoid it. So we don't want to, if we want to avoid, and we'd probably do underpayment penalties or penalties interest, whatever you'd want to call it, there are a couple ways to ensure that we won't. So, and it's all based on past tax bills or projected current tax bills. So safe harbors would be pay a hundred percent of last year's tax bill in four equal chunks or 110 % of last year's bill if your income is over 150,000. or pay 90 % of this year's bill. If we hit any