Paying Taxes in Retirement With Tax Withholding Distributions

[TheWizard]

Ok. So, you don't need to replenish your 401k or T-IRA?

That 60-day tIRA replenishment scheme allows one to effectively pay their taxes for the year in December by doing "withholding" from their taxable account.
If that tIRA is not replenished, then that distribution is Ordinary Income added to their AGI.

And as I mentioned earlier, you can't do this once you are subject to RMDs...

 

[Out-to-Lunch]

As a reminder, you can only do an indirect rollover from an IRA once every 12 mos. However, you can do it as often as you want from a qualified account, i.e., 401(k) and the like.

 

[sengsational]

The strategy seems very common with the members here. I also "pay my taxes" in December when I pull from a not-yet-taxed retirement account.

This is the time of year I do my taxes. Doing them today. I have an "inputs sheet" that I maintain, and things don't change too much year to year, so typing the values (and of course some estimates) takes just a few minutes. Then it takes a while to iterate on tIRA withdrawals and/or Roth conversions to land where I want in the marginal tax rate spectrum. Since I'm using the full tax return calculation, it includes everything, including ACA PTC.

But at the end, I know what I'll need to withhold for both federal and state. The tax software guides me through filling out the form so I don't get a penalty.

 

[jollystomper]

Ok. So, you don't need to replenish your 401k or T-IRA?

Correct. I have no need to. My withdrawal to use for taxes is less than .5 percent of the total 401K/tIRA values.

 

[BizzyC]

I'm confused.

Can you only do this if you are >=59.5 years old and thus have penalty free access to your 401k/IRA account, or is the repayment from some other source (a taxable account, savings) a mechanism to repay what was borrowed from the 401k/IRA to avoid the penalty for pre 59.5 withdrawal?

 

[OldShooter]

I do not like to pay fees, or interest. So I pay my taxes. On time.

Yup. Agree. Me, too. Since I pay via withholding, "on time" for me is before the end of December.

Something else I don't recall being mentioned in this thread is eliminating any fussing with estimating taxes by simply paying the safe harbor amount, 100% or 110% of last year's taxes.

 

[Mountain Climber]

I learned this strategy from the people on this site and have used it for several years. I find the process easier than the quarterly payment process. My current monthly tax withholding from my pension is for my pension income. By mid-December I will have modeled my 2023 tax return covering all of our income. At that time I will make a withdrawal from my 401k, with the vast majority of it withheld for federal and state taxes.

I do not worry about replenishing, my 401K is big enough that much of it will not be converted to Roth by the time I reached RMD age. I see this as potentially reducing those future RMDs (though even with these withdrawals to pay taxes the 401K is still more than when I retired, first world issue ).

+1 - Very fortunate to have to deal with these "first world issues".....

 

[Tom57]

Yes, I have been doing this for the last 21 years. I have a spreadsheet that does my estimated federal income tax and it is accurate to within $3 of my actual income tax return. I live in Nevada so NO state income tax. On or around December 1, I make 2 RMDs, the first one for federal income tax since Vanguard only allows up to 99% income tax withholding on RMDs. The second RMD has zero income tax withholding. Works great.

 

[Al18]

Seems like lots of fussing and planning, especially if you’re in the 12% tax bracket.

I’ve been retired 5 years and over 59 1/2, and have Fidelity withhold 10% Fed tax when I do a Roth IRA conversion, which is too much. I’ll withhold 9% when I do this next year.

No need to withhold anything for NJ taxes, because once you are 62 withdrawals from retirements accounts are tax free up to 100K/year and SS is not taxed by the state.

No need to pay estimated or quarterly taxes.

 

[jazz4cash]

You may "borrow" from your IRA tax free as long as the full amount of the distribution is returned to an IRA within 60 days.

So take a withdrawal, withhold as needed, return the withdrawal within 60 days.

End result is no taxable income and tax payment done.

Better to not wait 60 days, especially if that puts you into new tax year. Does not change tax result but could complicate your tax filing.

This seems to be putting after tax funds into the IRA where they will get taxed again when it is eventually distributed. If you could even rollover after tax funds into an IRA.

 

[Montecfo]

This seems to be putting after tax funds into the IRA where they will get taxed again when it is eventually distributed. If you could even rollover after tax funds into an IRA.

No. The funds are not taxable if returned to a qualified plan within 60 days. This is the so called "60 Day Rule". It is simply a method to fund a tax payment through withholding, which is treated more favorably, instead of an estimated tax payment.

 

[TheWizard]

Yes, I have been doing this for the last 21 years. I have a spreadsheet that does my estimated federal income tax and it is accurate to within $3 of my actual income tax return. I live in Nevada so NO state income tax. On or around December 1, I make 2 RMDs, the first one for federal income tax since Vanguard only allows up to 99% income tax withholding on RMDs. The second RMD has zero income tax withholding. Works great.

What does two RMDs mean?
Do you have one RMD from a tIRA and another from a 401(k)?

 

[audreyh1]

I think he just means two withdrawals/distributions.

 

[scrabbler1]

I prepare the tax returns for my (snake-bit) friend, who is 60 but not retired. He has an inherited IRA since 2012 and has to take an RMD every year from it.

Another part of the inheritance included a large portfolio (half of it; he split it with his sister) which generates income so we use the RMD to pay the additional taxes due that.

What I do as [art of my financial service for him (for a small fee) is to have federal and state income taxes withheld from the RMD to make his taxes due in April as close to zero as possible, erring on the side of being due a small refund (less than $100) which we will roll over into the following year. This way, no money has to change hands when I file his returns and he not forgoing any significant refund.

I wait until the end of the year to take his RMD so I will have as much data as possible about his income. This includes nearly all of his pay stubs and nearly all of his year-end distributions.

There are some unknown I won't learn about until he received his 1099s in January and February (and, sometimes, March). I can only estimate the amount of qualified dividends in his stock funds as well as any non-dividend (and non-taxable) distributions. I can usually use the prior year's qualified dividends as a starting point. But NDD are a different animal. For the last few years, I have been able to locate monthly financial reports for the each fund (there are 2 funds) which list any NDD (also called return of capital) on a fiscal year-to-date basis. This data has been very useful, especially when the percentage or NDD changes during the year.

Another item I won't know until the 1099s come out is the percentage of home-state dividends from national muni-bond funds. Here, again, I use the prior year's percentage because it doesn't change much from year to year, and the amount involved is pretty small.

As long as I don't make any mistakes in my tax spreadsheets (another possibility which has occurred), I can get to my desired "no-money-changes-hands: small refund amount with his RMDs on his federal and/or state returns.

 

[jazz4cash]

No. The funds are not taxable if returned to a qualified plan within 60 days. This is the so called "60 Day Rule". It is simply a method to fund a tax payment through withholding, which is treated more favorably, instead of an estimated tax payment.

I am very familiar with the 60-day rollover rule but I am Super confused by this scheme. The funds being rolled over have already been taxed. They will be taxed again when they eventually come out of the IRA. If you are "rolling over" funds that have already been taxed you could just use them to pay the taxes. Since 60 day rollovers are limited to 1 per 12 months, I would not 'waste a rollover on this scheme. The funds being rolled over generally show up on a 1099 being issued by the prior custodian. In this case taxable funds would show up on some other type of 1099.

 

[TheWizard]

I am very familiar with the 60-day rollover rule but I am Super confused by this scheme. The funds being rolled over have already been taxed. They will be taxed again when they eventually come out of the IRA. If you are "rolling over" funds that have already been taxed you could just use them to pay the taxes. Since 60 day rollovers are limited to 1 per 12 months, I would not 'waste a rollover on this scheme. The funds being rolled over generally show up on a 1099 being issued by the prior custodian. In this case taxable funds would show up on some other type of 1099.

The problem is: you can't do withholding from taxable funds on December 15th, whereas you CAN do withholding from a tax-deferred account withdrawal.
There's no double taxation involved either. Think about it more...

 

[jazz4cash]

I'm thinking....Let's say I take a dollar from my savings account which is after tax money and put it into my IRA as a 60 day rollover. Doesn't that dollar get taxed when I eventually take it out of the IRA?

 

[Phroig]

I'm thinking....Let's say I take a dollar from my savings account which is after tax money and put it into my IRA as a 60 day rollover. Doesn't that dollar get taxed when I eventually take it out of the IRA?

Take a $100 distribution with a $10 withholding, so $90 going to the bank account. Send the $90 plus an additional $10 back to the IRA. Get a $10 credit towards your other taxes (or a refund) at tax time, since you don’t really owe a tax on the IRA distribution. Your taxable account is short $10 only for the time period from the reinvestment to tax time, so you aren’t really putting taxed dollars into the IRA to be taxed again.

 

[rayvt]

Say you figure that your federal safe-harbor amount will be $10,000.
In mid-December do a withdrawal from your T-IRA of $10,000 with 100% withholding.
That takes care of your withholding requirement.

On Jan 1 (2 weeks away), you have a new RMD for the new year.
So mid-January you withdraw $10,000 from the T-IRA, and do a 60-day rollover back to the T-IRA. (It doesn't have to be to the same IRA account, can be to any of your T-IRA accounts.)
Note that for this to work NONE of the mid-December withdrawal can be part of your RMD; you will have had to already taken your entire RMD.
That does two things:
1) Satisfies $10,000 of your RMD.
2) Puts back the $10K that you withdrew in mid-December (4 weeks ago).
3) Thereby negates the tax on the $10K mid-December withdrawal.

In a nutshell, you use the RMD of *next* year to pay the withholding of *this* year.

No funny business and no shady business. You just have to do it within the 60-day window.
You still have to take your entire RMD before you can do a Roth conversion. But you have to take your RMD anyway, it's just that $10K of it gets used for a timely withholding for the previous year.

 

[temartin]

How to return funds to IRA - over yearly contribution limit.

I understand the scheme - withdraw from tIRA end of year and have year's tax withheld, then redeposit same amount funds from elswhere to IRA within 60 days. So you've paid your taxes and no income from the IRA since it's rolled back.

However, how do you redeposit the funds. My taxes are over 30K. Did a fake test run at Schwab and Fido and they won't let me deposit that much to IRA online as it's over my yearly contribution limit.

Do you have to call and tell them you're doing an indirect rollover, or take in a check or what?

UPDATE - Answered!

So after digging around in the mobile apps, you can deposit a check using the apps (Fido and Merrill Lynch at least) and designate it as a 60 day rollover.

You can't do it on the websites...

 

[OldShooter]

I'm warming up to this. What is the reporting situation? The 1099-R from the brokerage will still reflect the $10K that was temporarily withdrawn, right? Is there some IRS form associated with the replacement funds?

 

[jazz4cash]

Take a $100 distribution with a $10 withholding, so $90 going to the bank account. Send the $90 plus an additional $10 back to the IRA. Get a $10 credit towards your other taxes (or a refund) at tax time, since you don’t really owe a tax on the IRA distribution. Your taxable account is short $10 only for the time period from the reinvestment to tax time, so you aren’t really putting taxed dollars into the IRA to be taxed again.

Why aren’t the dollars going into the IRA taxed? My marginal rate is 25%. I had to earn 90/(1-.25)=120 to get the 90 residual which I’ve paid $35 of taxes on. Now the 90 is aftertax until I put it into my IRA and call it a rollover. Plus the extra 10 cost me >13 including the taxes. Eventually that $100 payment back to the IRA will be taxed again.

 

[G-Man]

So, this strategy would not work if someone took a single distribution in the prior year (in December) for the current year living expenses. I'm I thinking about this correctly?

 

[jazz4cash]

So, this strategy would not work if someone took a single distribution in the prior year (in December) for the current year living expenses. I'm I thinking about this correctly?

The idea was to have taxes withheld (sent to IRS) in the prior year. You would need to increase the distribution to cover living expenses for the current year. That would not favor the taxpayer since the taxes would be due in April of the current year. If you waited to take a distribution for living expenses in Jan of the current year taxes for that distribution would not be due until April of the next year. If I was going to go this route I would take a distribution in Jan for living expenses with zero withheld and a 2nd distribution in Dec with ~100% withheld.

 

[G-Man]

The idea was to have taxes withheld (sent to IRS) in the prior year. You would need to increase the distribution to cover living expenses for the current year. That would not favor the taxpayer since the taxes would be due in April of the current year. If you waited to take a distribution for living expenses in Jan of the current year taxes for that distribution would not be due until April of the next year. If I was going to go this route I would take a distribution in Jan for living expenses with zero withheld and a 2nd distribution in Dec with ~100% withheld.

That is what I was trying to figure out. Thanks for the reply. This has been an informative topic for me.

The second distribution would equal the amount of taxes owed in the current year. Then you would replenish the taxed deferred account (T-IRA/401k) with dollars from a taxable account. Is that correct?