If you’ve been an employee all your life, you’re used to your employer taking out the taxes required each pay period. You may not know that once you retire, you are responsible for paying your taxes throughout the year. In retirement, paying taxes may no longer be a once a year event when you file your tax return. Now you must be sure you are paying your taxes as they are due. Our U.S. tax system is a “pay as you go” system, which requires taxes to be paid on income as you receive it.
Do I need to pay estimated taxes?
If you have substantial income in retirement from investments, you may need to pay estimated taxes. Common sources include rent, alimony, withdrawals from taxable retirement accounts (IRAs, 401(k)s, etc.), and annuity distributions. Income, like consulting work, contract work, or self-employed work is also taxable. Any income that is received without federal tax withheld can be subject to estimated taxes. Failure to pay your taxes on time may result in penalties and interest on the amount that should have been paid.
However, there are some “safe harbor” amounts that generally are not penalized:
- You owe less than $1,000 in taxes for the current tax year. This requires estimating what your total tax will be before the year ends. For example, if your total tax owed for the current year is $2,000, and you have paid at least $1,001 to the IRS before December 31 of that year, you will likely not be penalized for the $999 you still owe.
- At the end of the year, you have paid at least 90% of what is due for that year. This requires that you estimate what you think you will owe at the end of the year, and that you will have paid at least 90% of that total to the IRS before December 31. For example, if you owe $12,000 in taxes and you have paid at least $10,800.
- In the current year, you paid 100% of your total tax owed in the previous year. If last year’s tax was $4,000, you must have paid at least $4,000 to the IRS in the current year before December 31.
- The amount of tax you owed in the previous year was zero.
If any of the above situations is true for you, you will likely have no penalty for the current year. Otherwise, you must pay estimated taxes.
How often are taxes required to be paid?
Taxes are required to be paid at least quarterly to satisfy the “pay as you go” requirements. For 2018, those dates are: April 17, 2018 (1st quarter), June 15, 2018 (second quarter), September 17, 2018 (3rd quarter), and January 15, 2019 (4th quarter).
How do I pay my estimated taxes?
You can pay your estimated taxes by check by downloading IRS 2018 Form 1040-ES, which includes payment vouchers for each quarter and information about where to send your check. If you want to pay electronically, you can use the IRS free payment system, called the Electronic Federal Tax Payment System (EFTPS) (www.eftps.gov/eftps). However, to set up your account with EFTPS you must first enroll in the program, and your information must be validated by the IRS. You will then receive a Personal Identification Number (PIN) from the IRS via U.S. mail, which could take 5 to 7 business days.
How can I avoid paying quarterly taxes but still meet my tax obligation?
Many retirees opt to have taxes withheld from incomes sources when it is possible. For example, numerous pensions allow retirees to instruct that taxes are withheld. If requested, Social Security will also withhold taxes. Most custodians of IRAs are also willing to withhold and submit taxes to the IRS on behalf of clients. As long as sufficient tax is withheld throughout the year, additional quarterly tax submissions may not be necessary.
Andrea L. Blackwelder, CFP®, ChFC and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with Wisdom Wealth Strategies.