Retirees face the challenge of managing various sources of income including Social Security, pensions, retirement plans, and other investments. In order to avoid IRS penalties, retirees must either withhold taxes or make quarterly payments. For the year 2024, the quarterly estimated tax deadlines fall on April 15, June 17, Sept. 16, and Jan. 15, 2025. While these deadlines are crucial, there exists a lesser-known year-end strategy that can help retirees meet their tax obligations while also complying with IRS rules.
Utilizing Required Minimum Distributions for Tax Withholdings
One effective strategy for retirees is to adjust missed tax payments through withholdings from mandatory yearly withdrawals known as Required Minimum Distributions (RMDs). Typically, RMDs are applicable to pretax retirement savings. This approach proves especially beneficial when retirees engage in activities like selling investments or real estate that result in taxable gains. JoAnn May, a certified financial planner at Forest Asset Management, emphasizes the importance of RMDs in helping retirees manage their tax liabilities effectively.
Diversification of Retirement Income
While Social Security benefits are a common source of retirement income, data from a recent Federal Reserve report shows that 56% of retirees also received pensions in 2023. Additionally, nearly half of retirees generated income from interest, dividends, or rental properties, and about one-third earned income from employment. As retirees’ income increases, the need for tax withholdings also escalates. Experts suggest that retirees should withhold more taxes or increase their withholdings to avoid penalties.
Strategic tax planning involves tracking income and tax liability throughout the year to optimize financial outcomes. Financial advisors recommend a proactive approach where retirees adjust their tax withholdings based on changes in income levels. In some cases, retirees may realize that they have not withheld the appropriate amount of tax from other income sources or have not made sufficient estimated tax payments. In such situations, leveraging annual RMDs for tax withholdings can be advantageous.
By utilizing annual RMDs for tax withholdings, retirees can benefit from a more streamlined tax projection process by the fourth quarter. This approach not only helps in meeting tax obligations but also allows for adjustments to be made if necessary. Planning RMDs in advance, as recommended by financial experts, provides retirees with the flexibility to rectify any tax-related issues before the year-end deadline.
Compliance with IRS Regulations
Under current regulations, retirees are required to initiate RMDs by the age of 73, as per changes introduced by Secure 2.0. By the year 2033, the age for initiating RMDs will increase to 75. The annual deadline for RMDs is set on Dec. 31, and failure to take the required minimum distribution or withdrawing inadequate amounts may result in a 25% penalty. For individuals turning 73, the initial RMD deadline is extended to April 1 of the following year.
Leveraging Required Minimum Distributions for tax withholdings can enhance the tax efficiency of retirees and ensure compliance with IRS regulations. By adopting a proactive approach to tax planning and utilizing RMDs strategically, retirees can optimize their financial strategies in retirement.