Retirees, Check Your Withholding Now Before an Unexpected Tax Bill Arrives
Key Points
Too little withholding can lead to a surprise balance due at tax time.
Paying quarterly taxes is an easy way to avoid an unwelcome surprise.
The IRS provides a Withholding Estimator that can make your life easier.
If you're retired and drawing funds from a 401(k), IRA, or other tax-deferred account, it's a good time to check your tax withholding. If you're not having taxes withheld from your account and haven't been paying quarterly estimated taxes, it's especially important to act if you want to avoid an unwanted tax bill. Here's why.
Image source: Getty Images.
Missed AI’s "Act 1"? Act 2 Could Be 15x Bigger. Most investors think they missed the AI boat because they didn't buy Nvidia in 2005. But according to our analysts, we’re only at the end of "Act 1"—the R&D phase. "Act 2" is the global rollout. Continue »
How retirees end up owing the IRS
You may face unique tax situations in retirement, including multiple income streams, irregular withholding, and changing rules. While you were working, your employer automatically withheld the right amount of tax from your wages. Or, if you were self-employed, you likely paid quarterly taxes to keep up with your tax bill.
In retirement, your income may come from several sources, including Social Security, pensions, annuities, and rental income. While each payment may feel considerably smaller than you became accustomed to while working, they add up, and the taxes you owe on the funds can add up, too.
It's easy to assume you can straighten the whole mess when you file taxes early next year, but by then, you may have racked up a significant underpayment penalty of up to 7%.
The bill comes due
Let's say you end up owing $10,000 in federal taxes for 2026 and have no withholding. You're surprised by how quickly those taxes accumulated, but still plan to pay them by April 15, 2027.
To keep the math simple, imagine that you should have paid your first quarterly estimated tax payment on April 15, 2026; the second on June 15; the third on Sept. 15, and the final installment on Jan. 15, 2027.
By April 15, 2027, the installment you should have paid on April 15 is 12 months late. The 7% penalty accrues like interest, adding to your tax burden.
Escape hatches
When you make estimated payments, you don't have to worry about getting it down to the penny. If you still owe money in April, two safe harbors allow you to avoid a penalty.
- If you owe less than $1,000 after subtracting withholding and refundable credits, you can skip the penalty.
- If you made estimated payments and paid at least 90% of this year's tax due, or 100% of last year's tax (whichever is smaller), you're also exempt from the penalty.
Practical steps to prevent a tax surprise
To help, the IRS offers a Tax Withholding Estimator. This online tool will walk you through income, deductions, and credits to estimate whether your current withholding will cover your entire federal tax bill. In addition, these steps can help you avoid underpayment:
- Compare your expected taxes with current withholding and estimated payments.
- Check to see if either safe harbor test applies.
- Adjust withholding from each source of income to close any gaps.
- Remember to rerun the numbers after major changes, such as a large withdrawal from your retirement account.
As with all retirement planning, tax planning can make your retirement more predictable, leaving you more time to relax and enjoy your life.
The Motley Fool has a disclosure policy.