Another quarterly estimated taxes question

[scrabbler1]

I have no taxes withheld during the year and have no opportunities to have taxes withheld, so the only ways I can pay them are through estimated taxes and when I file my return in April.

 

[audreyh1]

^^^^ I used to do it this way and went to doing a tax-deferred withdrawal and withholding instead of estimated tax payments... no need to do the annualized income method... much easier.

We don’t have the withholding option, and won’t for many more years.

 

[pb4uski]

One minor benefit of age I guess.

 

[racy]

FWIW, I just do a tax-deferred withdrawal in Dec for my estimated taxes and have that tax-deferred withdrawal fully withheld so my net proceeds are nil.... the IRS counts withdrawals as having be made throughout the year no matter when the withholding is done.

Am I understanding this correctly? You're withdrawing from your IRA the amount of your taxes due on taxable accounts?

 

[Dtail]

^^^^ I used to do it this way and went to doing a tax-deferred withdrawal and withholding instead of estimated tax payments... no need to do the annualized income method... much easier.

This is the methodology I will be using for my parents starting next year with their RMD's which they don't spend anyway.
Their tax guy has the estimated payments all over the place.

 

[Dtail]

One minor benefit of age I guess.

Both you and @Audrey1 are under 70.
I assume you are going this route as part of your stated strategy of using your TIRA accounts for spending before 70 in order to reduce the tax torpedo.

 

[audreyh1]

I guess we could withdraw from our IRAs to cover estimated taxes, but that would increase our taxable income considerably, and at a much higher marginal tax rate.

I have only considered earlier withdrawals for a Roth conversions, but so far that has not made sense for us tax wise.

 

[gerntz]

We get income during the year but pay by withholding only once, the second or third week of December. Both Fed and State.

That's how we've always done it in retirement/no earned income. Never have made an estimated tax payment.

 

[Cobra9777]

^^^^ I used to do it this way and went to doing a tax-deferred withdrawal and withholding instead of estimated tax payments... no need to do the annualized income method... much easier.

We're too young for tax-deferred withdrawals. Even after 59.5, I'll still prioritize Roth conversions to the top of the 12% bracket. After 70, I'll do RMDs in Dec and withhold the whole year's tax.

We each have a small pension but elected no withholding. I make quarterly payments that are as small as possible, but just enough to avoid penalties. This takes some planning and spreadsheet work but it keeps me amused.

First few years of ER were a bit volatile, tax-wise. I was exercising all my remaining employee stock options for a few years. DW decided to keep working OMY*3, and then we sold some rental property. I've also been squeezing in Roth conversions where I can. The first "normal" year was 2018, which then introduced QBI and all the other changes to the code.

With all that going on, I was doing lots of tax planning and analysis anyway. So it was just easier to make quarterly estimated payments and we frequently had to use the annualized income method, especially years with stock options or real estate sales. With things being much more stable now, I might convert to withholding on the pensions just for simplicity. I thought about doing 100% withholding in Dec, but one of the two pensions requires paper forms and snail mail. So probably not practical.

 

[audreyh1]

Any tax withheld from a Roth conversion is treated as a regular distribution according to https://www.retirementdictionary.com/tutorials/roth-ira-conversions .

Withheld Amount is Not A Conversion
Any amount withheld as tax from a Roth IRA conversion is treated as a regular distribution.

Example:
John request to have the 401(k) balance of $100,000 converted to his Roth IRA. He instructed the plan administrator to withhold 20% for federal tax. As a result only $80,000 was credited to the Roth IRA and 20% was remitted to the IRS as a pre-payment of tax for John.

The $20,000 that was withheld for tax is treated as a regular distribution and is subject to income tax and the 10% early distribution penalty on any taxable amount. The 10% early distribution penalty does not apply, if the conversion occurred when John was at least age 59 ½ of if john qualifies for one of the exception to the penalty.

So you lose the benefit of doing a full Roth conversion and paying taxes from after tax funds. And if you are younger than 59 1/2 you are subject to penalty on that withheld amount.

Some folks are drawing income from IRAs before RMD age, because for them that makes the most sense tax wise - they may not have much in after tax funds, and/or they may be drawing from IRAs for income and deferring social security. In such cases, being able withhold to pay estimated taxes is a bonus.

 

[OldShooter]

Yup, division is hard. Your DW is an ex-banker... maybe she can help you out with the math.

She is no more interested in doing the work than you are:

^^^^ I used to do it this way and went to doing a tax-deferred withdrawal and withholding instead of estimated tax payments... no need to do the annualized income method... much easier.

 

[OldShooter]

Any tax withheld from a Roth conversion is treated as a regular distribution according to https://www.retirementdictionary.com/tutorials/roth-ira-conversions .

So you lose the benefit of doing a full Roth conversion and paying taxes from after tax funds. ...

Huh? For any distribution I take at Schwab I can specify the amounts withheld for fed and state. Always zero until my December 100% withholding payment.

 

[audreyh1]

Huh? For any distribution I take at Schwab I can specify the amounts withheld for fed and state. Always zero until my December 100% withholding payment.

You aren’t doing Roth conversions are you? Different ballgame.

 

[Cobra9777]

Any tax withheld from a Roth conversion is treated as a regular distribution according to https://www.retirementdictionary.com/tutorials/roth-ira-conversions .

So you lose the benefit of doing a full Roth conversion and paying taxes from after tax funds. And if you are younger than 59 1/2 you are subject to penalty on that withheld amount...

Not sure if you were responding to my post (#34) or not... But we have no withholding on Roth conversions. All tax is paid from taxable funds. Perhaps you misunderstood something?

 

[RunningBum]

I think what Audrey is saying is that if you aren't required to take RMDs yet, and want to do Roth conversions, then using tIRA withdrawals to pay taxes via withholding may not be efficient. It's true that you can get the float of being able to convert or withdraw some early in the year and not pay taxes until the end of the year, but you also aren't converting the full amount of what you take out of your tIRA to a Roth.

In my mind, this is another version of "don't let the tax tail wag the dog": "Don't let the tax payment method was the dog."

 

[audreyh1]

Not sure if you were responding to my post (#34) or not... But we have no withholding on Roth conversions. All tax is paid from taxable funds. Perhaps you misunderstood something?

No, I was responding to the general discussion including pb4uski and OldShooter of under which circumstances using withholding from IRA withdrawals to pay estimated taxes is an option.

RunningBum summarized it very well.

If you aren’t drawing from an IRA yet to fund your living expenses, or to satisfy RMD requirements, withholding taxes as a one time thing at the end of the year is not an option.

You may have withholding from pensions and/or SS to cover estimated taxes, but these are generally paid evenly throughout the year as a fixed percent of each income payment.

If you are doing Roth IRA conversions you probably don’t want to use withholding because it reduces the amount you can convert, reducing the benefit of the Roth conversion. And if you are younger than 59.5 you will incur the 10% penalty on the amount withheld for taxes. Roth conversions are available at any age, but taxes withheld without penalty are only available to those older than 59 1/2.

 

[pb4uski]

Am I understanding this correctly? You're withdrawing from your IRA the amount of your taxes due on taxable accounts?

Yes.. but not just my taxable accounts... on everything. So if I do a computation of estimated taxes (mini-tax return) and I owe $10k then I would do a $10k tIRA withdrawal and have it fully withheld.

However, since the tIRA withdrawal is taxable, I have to take the $10k and divide it by (1- my 12% marginal tax rate) and do a withdrawal of $11,364 and have it fully withheld.

The tax at 12% on $11,364 is $1,364 so in effect I have withdrawn the $10k in tax on my other income and the $1,364 tax on the withdrawal.

 

[pb4uski]

Both you and @Audrey1 are under 70.
I assume you are going this route as part of your stated strategy of using your TIRA accounts for spending before 70 in order to reduce the tax torpedo.

I'm only 63.

While it plays into that tax torpedo strategy the main purpose is because they treat witholdings as paid throughout the year. You need to be over 59 1/2 to use it though because of the 10% penalty.

 

[kaneohe]

..................................................
If you aren’t drawing from an IRA yet to fund your living expenses, or to satisfy RMD requirements, withholding taxes as a one time thing at the end of the year is not an option.

............................................................

If you are doing Roth IRA conversions you probably don’t want to use withholding because it reduces the amount you can convert, reducing the benefit of the Roth conversion. And if you are younger than 59.5 you will incur the 10% penalty on the amount withheld for taxes. Roth conversions are available at any age, but taxes withheld without penalty are only available to those older than 59 1/2.

Alan S. from the fairmark.com forum has suggested a possible workaround.
Make a w/d from TIRA and do the desired withholding. Then depending on what you want to do: within 60 days.......

1) Replace the funds back into TIRA. TIRA is intact and w/h is accomplished.
or
2)Have the funds less w/h transferred to Roth. Replace the missing w/h and transfer to Roth. Roth is complete and w/h is accomplished.

There should not be any early withdrawal penalty there was no net withdrawal from TIRA or Roth conversion was done for all the funds. Of course you must be sure you follow the rule of only 1 IRA rollover every 12 mos or else there will be problems.

 

[ERD50]

Alan S. from the fairmark.com forum has suggested a possible workaround.
Make a w/d from TIRA and do the desired withholding. Then depending on what you want to do: within 60 days.......

1) Replace the funds back into TIRA. TIRA is intact and w/h is accomplished.
or
2)Have the funds less w/h transferred to Roth. Replace the missing w/h and transfer to Roth. Roth is complete and w/h is accomplished.

There should not be any early withdrawal penalty there was no net withdrawal from TIRA or Roth conversion was done for all the funds. Of course you must be sure you follow the rule of only 1 IRA rollover every 12 mos or else there will be problems.

Thank you, that might come in handy for me between now and RMDs.

I would check with my brokerage ahead of time to verify the logistics of this. Esp the Roth, I'm not sure exactly how you would add to the amount converted? Though #1 would be more likely for me, I'd keep any Roth conversion separate.

-ERD50

 

[kaneohe]

Thank you, that might come in handy for me between now and RMDs.

I would check with my brokerage ahead of time to verify the logistics of this. Esp the Roth, I'm not sure exactly how you would add to the amount converted? Though #1 would be more likely for me, I'd keep any Roth conversion separate.

-ERD50

Yes , it would be good to verify w/ them or perhaps w/ Alan S or both.
I think of the Roth conversion in 2 ways:
1) Direct conversion from TIRA to Roth (usually in-house)
2) "Indirect" rollover from TIRA to Roth(between 2 institutions)....you withdraw funds from TIRA and rollover within 60 days

The proposed possible Roth conversion is like a hybrid of the 2 techniques....part of it is conventional; the w/h and replacement is like the indirect rollover.

Perhaps it might be more straightforward to replace the w/h
back into the TIRA. Then you could do a normal Roth conversion of that part .

 

[audreyh1]

Alan S. from the fairmark.com forum has suggested a possible workaround.
Make a w/d from TIRA and do the desired withholding. Then depending on what you want to do: within 60 days.......

1) Replace the funds back into TIRA. TIRA is intact and w/h is accomplished.
or
2)Have the funds less w/h transferred to Roth. Replace the missing w/h and transfer to Roth. Roth is complete and w/h is accomplished.

There should not be any early withdrawal penalty there was no net withdrawal from TIRA or Roth conversion was done for all the funds. Of course you must be sure you follow the rule of only 1 IRA rollover every 12 mos or else there will be problems.

Wow - well, I think I’ll stick to my current method of paying quarterly estimated taxes. If I’m willing do compute annualized income (run a couple more spreadsheets), I don’t have to pay much in estimated taxes until Jan 15 of the next year anyway, as ~90% of my taxable income is received in Q4+September.

BTW if the goal is to do an IRA withdrawal late in the year, withholding for estimated, then turnaround and pay it back, you had better get it all square before the end of the year.

 

[kaneohe]

........................

BTW if the goal is to do an IRA withdrawal late in the year, withholding for estimated, then turnaround and pay it back, you had better get it all square before the end of the year.

I guess we'd have to go to Alan S. for a credible answer but I'm not sure the yr end square is necessary, tho it would be cleaner. There is stuff like recharacterization of IRA contributions that can be done in the 2nd yr by deadline......you just have to include a narrative explaining what happened or perhaps some key words on the form.

btw.......I still do the quarterly payments like you despite my longing to do the withholding......don't understand why but it feels I'm more in control and not depending on somebody else to do things right.

 

[pb4uski]

I'm doing withdrawals to pare down the tax deferred balances before RMDs so I just integrate the withdrawals for federal and state taxes in my calculations.

I understand the idea of doing a withdrawal with withholding and replacing the funds but I'm trying my best to reduce tax deferred.

 

[jollystomper]

Correct. So if your marginal tax rate is 22% and you want to pay $10,000 in tax you need to withdraw $12,820 because the $12,820 withdrawal will result in $2,820 in tax.

$12,820 = $10,000/(1-22%)

I am going to do this for this tax year (my first full year of retirement). It seems so much simpler than dealer with the quarterly estimated payments. But I may not do it in one fell swoop, maybe a couple of times during the year. For example, now is a good time for us as our tax-deferred has hit another peak. The big unknown is the end of year mutual fund capital gains, so we will be prepared for that.