How to Pay Estimated Taxes in Retirement: Year-End IRA Withholding vs. Estimated Tax Payments

For many of us, paying income tax isn’t a concern. We work, we earn a salary, an appropriate amount is taken out of our paychecks by our employers, and that’s that. We don’t think much about it until it’s time to file income tax returns every April.

However, if you’re retired and taking distributions from your retirement accounts, you may have multiple sources of taxable income that aren’t related to employment. Paying estimated taxes in retirement can involve withholding from pensions or IRA distributions, quarterly estimated tax payments, or both. When the timing or amount is wrong, you could pay too much, pay too little, or face an underpayment penalty.

That’s where financial planning services can help guide your decisions and reduce the risk of costly tax missteps. With support from experienced wealth planners, you can compare IRA withholding vs. estimated tax payments and determine whether year-end IRA withholding could simplify the process or help address a late-year shortfall. The strategy requires careful attention to estimated-tax safe harbors, required minimum distributions, rollover eligibility, and custodian procedures.

Retirees can pay federal income tax through withholding from pensions, annuities, IRAs, or other retirement distributions; quarterly estimated tax payments; or a combination of both. Because federal withholding is generally credited evenly across the year for underpayment-penalty purposes, year-end IRA withholding may help correct a shortfall. An RMD may be used for withholding, but the RMD itself cannot be rolled over.

Let’s briefly compare the main options for paying estimated taxes in retirement.

Estimated Taxes in Retirement: Withholding, Quarterly Payments, or Both

In many cases, federal income tax can be withheld from your retirement account distributions much like it is withheld from wages. For a nonperiodic IRA distribution, 10% is the default federal withholding rate, but Form W-4R generally lets you elect a rate from 0% to 100%. Eligible rollover distributions from employer plans are generally subject to a minimum 20% federal withholding rate when paid to you instead of sent through a direct rollover. Periodic pension and annuity payments generally use Form W-4P.

You can also make quarterly estimated tax payments using Form 1040-ES based on your expected income, deductions, credits, and tax for the year. Rather than having tax withheld from each distribution, you can keep more of the distribution and make payments to the IRS, generally in four installments. You can also combine both approaches—for example, by making estimated payments during the year and using IRA withholding later to cover a remaining projected shortfall.

These methods, however, can be complicated. Keeping track of withholdings throughout the year can be challenging, depending on your circumstances. It can also be difficult to remember to make estimated quarterly payments on time, as well as determine what amounts those estimated quarterly payments should be.

Get premier guidance from one of our tax specialists. Book your complimentary strategy consultation now.

One-Time Tax Withholding Distribution

In some situations, it may make sense to limit withholding earlier in the year while monitoring income and estimated-tax safe harbors. Later in the year, you can calculate the projected tax more accurately and request substantial—or even 100%—federal withholding from a nonperiodic IRA distribution using Form W-4R. This does not erase the tax on the distribution: Unless the payment is rollover-eligible and properly rolled over, the gross distribution generally remains taxable.

This strategy can simplify the process by using one source for a late-year tax payment instead of withholding from multiple income sources or relying only on quarterly estimated payments. It may also serve as a true-up after estimated payments made earlier in the year. The amount should be based on a current tax projection, not simply the anticipated filing-time balance.

There are three potential advantages to this strategy:

1. Simplify the tax-paying process
2. Provide more time to determine the appropriate amount of tax to be paid
3. Potentially keep funds invested longer before they are used to satisfy the year’s tax obligation

In a carefully structured case, year-end IRA withholding may be followed by a 60-day rollover funded from the individual’s taxable account. To avoid tax on the full gross distribution, the taxpayer must replace the entire amount withheld with outside funds within 60 days. The distribution must be rollover-eligible, the RMD portion must be excluded, and the IRA-to-IRA once-per-12-month rollover limit must be available.

Year-end IRA withholding can provide more time to determine the appropriate amount of tax, especially for people with variable income, because the projected liability may be clearer in November or December. Until then, funds that otherwise might have been sent as estimated payments can remain invested. That creates an opportunity for additional earnings, but it also exposes the funds to investment risk and does not excuse a failure to meet the applicable safe-harbor requirements.

For federal underpayment-penalty purposes, income tax withholding is generally treated as paid evenly across the year, even when it is taken from a December IRA distribution. A taxpayer may instead elect to use actual withholding dates on Form 2210. This timing rule can make late-year withholding useful, but it does not mean there is “no downside”: An inaccurate projection, an ineligible rollover, a missed 60-day deadline, or different state rules can still create tax, penalties, or cash-flow problems.

Savvy Tax Withholding Strategy

To see how such a plan might work, suppose a hypothetical John Smith has not made any estimated tax payments or elected any withholding to cover his tax bill by December 2022. Then, John calculates he will owe $30,000 in tax, so he takes a $30,000 distribution from his IRA and designates $30,000 of tax withholding. The next day, John moves $30,000 from a taxable account to that Traditional IRA, so the $30,000 distribution is considered “rolled over” and not counted as taxable income.

Generally, you have 60 days to roll over the amount of money used for the tax withholding distribution back to the IRA or other retirement account from which the money came to avoid income tax. Individuals can make only one rollover from an IRA to another in any 12-month period under this 60-day allowance. Note that Roth IRA conversions aren’t subject to this once-per-12-months rule (more below on how Roth IRAs can fit into this strategy).

Suppose you will perform a rollover or conversion by taking advantage of the 60-day window. In that case, we recommend you complete the rollover within a day or two of the tax withholding distribution. Thus, this strategy only works if you already have the funds and are ready to act accordingly. This strategy shouldn’t be treated as a loan to pay your taxes. The 60-day window goes fast, and you don’t want to end up paying taxes on the money you used to pay your taxes!

Looking at a Real-World Example

Keep in mind that these tax withholding distributions can go beyond the tax owed on retirement account distributions. If executed properly, they can cover the tax from all sources of income.

For example, let’s look at a real-life case study for a client we’ll call Ann. Ann owns a successful, independent pet store, and her estimated taxes for one recent year were going to be $200,000 per quarter, based on the prior year. However, a big box retailer moved nearby, causing Ann to fear her business would fall into the red.

Not wanting to commit to that tax obligation, Ann omitted the estimated tax payments. As it turned out, the big box retailer alienated the community, and Ann’s company had its best year ever! We had Ann take $800,000 out of an IRA in December of that year, withholding 100% of that $800,000 to cover federal and state tax.

Ann wrote an $800,000 check back to the IRA on the same day to avoid any tax on the distribution. She was extremely grateful to use several hundred thousand dollars for working capital during the year. On the other hand, if her business had lost, it would not have needed to make such a large December distribution—or could have made no distribution at all, with no tax due.

Creative Roth Conversions

As mentioned, Roth IRA conversions are not subject to the once-per-12-month limit that applies to IRA-to-IRA 60-day rollovers. However, an RMD must be taken first and cannot be converted or rolled over. A taxpayer may use a variation of year-end IRA withholding with an otherwise eligible conversion.

In a Roth IRA conversion scenario, the account owner could request a reasonable amount of federal tax withholding from the Traditional IRA distribution. Because the withheld amount is not deposited into the Roth IRA, the taxpayer would need to replace it with outside funds within 60 days to convert the full gross amount. Any amount not replaced remains a taxable distribution and may be subject to the 10% additional tax if the owner is under age 59½, unless an exception applies.

For example, on a $50,000 Roth IRA conversion, $15,000 might be withheld for taxes and $35,000 deposited into the Roth IRA. The taxpayer could then deposit $15,000 of outside funds into the Roth IRA within 60 days to complete a $50,000 conversion. This may simplify the year-end payment process and help satisfy a safe harbor, but the result depends on the taxpayer’s full-year projection, rollover eligibility, age, and timely execution.

Is Year-End IRA Withholding Right for Me?

Tax withholding distributions are not for everyone, but they work well for certain people who know what can be done. Take some time to discuss with your financial advisor if tax withholding distributions are right for you.

Additionally, some of these strategies take advantage of the 60-day rollover rules. We don’t advocate using rollovers unless it is necessary. Moreover, the restrictions on IRA rollovers may cause us to use other accounts such as solo 401(k)s for any rollovers, if possible, as solo 401(k)s are not subject to the once-every-12-months rollover rule.

FAQs About Year-End IRA Withholding and Estimated Taxes in Retirement

1. Does December IRA withholding count as paid throughout the year?

Generally, yes. For federal underpayment-penalty calculations, income tax withheld from an IRA distribution in December is usually treated as if one-fourth had been paid on each estimated-tax due date during the year. This can make late-year withholding more useful than a late estimated payment, which is credited when paid.

Conditions and exceptions:

• This is a federal underpayment-penalty allocation rule. It does not change when the IRA distribution is taxable or extend the tax-return filing deadline.
• A taxpayer may elect on Form 2210 to use the actual dates on which withholding occurred instead of the default allocation.
• State treatment can differ, so state withholding and estimated-payment rules should be reviewed separately.

2. Can I withhold 100% of an IRA distribution for taxes?

Generally, yes. For a nonperiodic IRA payment, Form W-4R lets you choose a federal withholding rate from 0% to 100%, so an entire distribution can be sent to the IRS. Your custodian’s procedures, state withholding rules, and the taxable amount of the payment can affect how the transaction is processed.

Conditions and exceptions:

• The default federal rate for a nonperiodic IRA payment is generally 10%, but you may elect another permitted rate on Form W-4R.
• Eligible rollover distributions from employer plans that are paid to you are generally subject to at least 20% federal withholding, rather than the 10% IRA default.
• Electing 100% withholding means you receive no cash proceeds from that distribution. You would need outside funds to complete a full 60-day rollover.
• An RMD may generally have tax withheld from it, but the RMD itself cannot be rolled over.

3. Can year-end IRA withholding help avoid an underpayment penalty?

It can. Because federal withholding is generally allocated evenly across the year, a properly sized year-end IRA withholding election may help satisfy an estimated-tax safe harbor and reduce or eliminate a federal underpayment penalty. It does not work automatically: total withholding and timely payments must meet the applicable threshold.

Conditions and exceptions:

• The amount should be calculated using a current full-year tax projection and the applicable 90%, 100%, or 110% safe-harbor threshold.
• Meeting a safe harbor may prevent a penalty but does not necessarily eliminate the balance due with the tax return.
• A payment that remains insufficient after the year-end withholding may still result in a penalty.
• State penalty and withholding-credit rules may not follow the federal treatment.

4. Can I use an RMD for tax withholding, and can an RMD be rolled over?

You can generally request federal tax withholding from an RMD, including a high withholding rate when your custodian permits it. However, the RMD itself is not an eligible rollover distribution and cannot be rolled back into an IRA or another retirement plan. Any strategy that relies on a 60-day rollover must exclude the RMD amount. 

Conditions and exceptions:

• The RMD must be distributed by the applicable deadline and cannot be converted to a Roth IRA.
• When a distribution exceeds the RMD, only the amount above the RMD may potentially qualify for rollover treatment.
• Withholding from an RMD can be applied toward the taxpayer’s overall federal income tax liability, not merely the tax attributable to the RMD.
• Custodian procedures and state withholding requirements may limit how the election is processed.

5. How does the 60-day rollover work when tax was withheld?

If an eligible IRA or plan distribution is paid to you and tax is withheld, the 60-day period generally starts when you receive the distribution. To roll over the full gross amount, you must replace the withheld dollars with other funds by the deadline; otherwise, the withheld portion remains taxable and may face additional tax.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended as a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

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