If you’ve been an employee all your working life, you’re probably used to having income tax withheld from your pay.
When it comes time to retirement, however, you might be surprised to find you may need to make estimated tax payments on your income four times a year.
For some people, the days of simply filing a tax return at the end of the year and paying any taxes due are gone.
They may end up owing penalties and interest on the amounts they should have paid throughout the year if they failed to make estimated tax payments.
So, how do you know if you need to make estimated tax payments or what alternatives are available?
Here are the answers to the most commonly asked questions about estimated tax payments.
Do I need to make quarterly estimated payments?
If you have substantial income from investments, taxable retirement plan withdrawals or other sources from which you do not have income tax withheld, you probably need to make quarterly estimated payments to avoid penalties and interest.
However, if your income is low you may owe little to no federal income tax. For instance, if you owe less than $1,000 after you file your taxes, you won’t owe a penalty.
If your income was modest in the previous year, the safe harbor rules may also keep you from owing penalties and interest.
If your total income tax withholding and timely estimated tax payments equal at least 90 percent of the tax shown on the current year’s return, or 100 percent of the tax shown on your previous year’s tax return, you won’t pay a penalty.
If your tax liability last year was zero, you typically don’t have to make estimated tax payments throughout the current year.
The easiest way to determine if you will owe more than $1,000 in tax for the year is to use TaxAct’s Tax Calculator to estimate your taxes.
Can I avoid estimated tax payments?
It’s not hard to make estimated tax payments. However, if you really don’t want to be bothered with them, here are two alternatives:
- Increase withholding on income. You can have income tax withheld on retirement withdrawals or other types of income. If your spouse is still working, he or she might consider increasing his or her income tax withholding. .
- Take more withdrawals from tax-free retirement plans. If you have Roth and traditional IRAs, for example, plan your withdrawals to minimize your taxable income for the year.
- Practice good tax planning. If the thought of making estimated payments motivates you to plan your tax year more carefully, that’s a good thing. For example, consider making charitable contributions and paying deductible expenses before the end of the year. Don’t take more taxable retirement withdrawals than you need. You may also want to consider selling investments that have decreased in value when it is tax advantageous for you to do so.
How do I make quarterly estimated tax payments?
If you need to make quarterly payments, you can calculate the amount you need to pay with TaxAct’s Tax Calculator and print out quarterly payment vouchers.
Each quarter, you’ll need to print a voucher, attach a check or money order to it and mail it to the IRS by each voucher due date.
If you’d rather pay electronically, you can set up Electronic Funds Withdraw (EFW). This can also be done through TaxAct, and your quarterly payments will be deducted from your bank account automatically.
The IRS also has a free payment system called Electronic Federal Tax Payment System (EFTPS). You can set it up at www.eftps.gov/eftps.
However, you’ll need to plan ahead to use EFTPS as it requires you to receive an EFTPS Personal Identification Number (PIN) and set an Internet password.
Another option is to make your payments by credit or debit card using the phone system and website set up by the IRS. This should be a last resort because you’ll likely pay an additional convenience fee to your bank with this method.
Don’t forget you may need to make state estimated tax payments if your state has an income tax.
Estimated tax payments are due on April 15, June 15, September 15, and January 15. When a due date falls on a weekend or holiday, the due date is the following business day.
I recently retired, but haven’t made estimated tax payments. Am I in trouble?
Go ahead and relax on this one. You’re not the first retiree to be surprised by the requirements for estimated tax payments.
The worst that can happen is the IRS may charge you penalties and interest based on the difference between when you should have made payments and when you actually do.
In some cases, if you end up with a penalty, you may be able to have it abated for at least the first time period in which you should have made an estimated tax payment.
To receive this potential abatement, you’ll need to write the IRS, explain the situation and specifically ask for an abatement of penalties.