Today I want to address another common question I get when it comes to a lot of my clients that are retiring or are very close to retirement. The question is, “Jeff, how do we take care of the taxes whenever we are taking distributions out of our IRAs?” It is a very common question I get. Most typically why I get that question is because whenever they are talking to their HR department with their 401Ks or pension, they are commonly told if they do a distribution from there, they're going to withhold 20% on federal income tax. That is typically an IRS standard where if you are taking distribution from a 401K or pension, by standard that is how much they are going to withhold, so they just assume that that is how much we are going to withhold on our end, and that is not the case.
Decide on The Tax As You Go
Whenever you actually roll your pension or 401K into an IRA, you then can decide how much tax you want to have withheld. Let me give you an example. A lot of clients that do retire with me, now that you're retired your income is going to be different. Maybe you've retired at the beginning of the year, so you have no other wages other than your retirement income, then that will be pretty easy to gauge what the federal income tax that you owe. But let's say that you've been working for three or six months of that year and now you have some W2 wages for that period of time, and now you tack on the IRA distributions. Then we'll have to “re-guesstimate” what your tax bracket might be. You might want to withhold more than that typical 20%. For the most part, I usually do have my clients withhold 20% on the federal income tax side just because it is the first year, and we don't know exactly how much taxes that we'll have to pay at the end of the year, so 20% is a safe number.
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After that first year, we can actually gauge was that too much? If it is, we can actually recalculate that and nip it down. I have one client in particular that after their first year of retirement, I think we were doing 20% initially. He was actually able to go back after that year, and now we're having 17% withheld from his. That is the perfect amount that he needs to have withheld so he owes no federal income tax at the end of the year. Now each situation is going to be different.
News Flash: You Don't Have to Withhold Taxes
Here is the other thing; you don't even have to have taxes withheld on your distributions, as far as if you're getting a monthly paycheck from your IRAs. You can actually settle up at the end of the year and the IRS- you'll get your 1099- shows how much was distributed out of your IRA. If you have had nothing withheld through that whole calendar year, then you will just tack that on whenever you do your taxes, and then you'll find out how much taxes you actually owe. I will say, for the most part, I don't think any of my clients actually do that. If I have, it might be just one, but typically they like to just have some of it taken out, and it just goes on the side like an escrow account to where it is just there to where the IRS has a record of how much taxes you had withheld so that at the end of the year you are not having to pony up extra cash to pay for that.
That is how easy we set it up. It is on the form that we set up to get your distributions going, and that is really how simple it is. That is how we figure out how much tax you have withheld on your IRA distribution. I hope that answers that question. If you have any other questions, please feel free to hit me up on the blog, goodfinacialcents.com. I have tons of stuff there. I have more going on, more videos to come. Thanks for joining me, and we'll see you next time.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.