Retirement income can come from several sources. You may find the combination of taxable income and nontaxable income confusing, and may not have sufficient taxes withheld to pay federal income taxes. You may have to pay quarterly estimated taxes to the Internal Revenue Service if you have insufficient withholding. Because the tax system requires you to pay as you earn, penalties apply if your payments are insufficient. Estimate your taxes each year of retirement to avoid underpayment or penalties.
Social Security Retirement
1. Determine your total income for the year. If Social Security retirement is your only significant income, you will not owe federal income taxes. If you continue to work or have other income, you may owe federal income taxes on your employment income and part of your Social Security retirement income.
2. Refer to IRS Publication 915 worksheet to estimate if you owe taxes on Social Security retirement. The IRS calculates combined income, or half of your Social Security benefits, plus any nontaxable interest added to your adjusted gross income (AGI). If your combined income is greater than $25,000 as a single person, or $32,000 if you are married filing jointly, you will owe federal income taxes on part of your Social Security benefits.
3. Use last year’s federal income tax return as a calculator. Plan to pay 100 percent of last year’s tax, unless your income was more than $75,000 as an individual or $150,000 as a couple. Calculate 110 percent for taxes in the higher income group.
4. Adjust last year’s income for this year’s estimate. Greater income than last year will likely incur more taxes. Use the combined income figure estimate if your income is less than $34,000 as a single filer, or $44,000 if married and filing jointly. If your income is greater than this amount, you will have to pay taxes on 85 percent of your annual Social Security retirement income. Add an allowance for the additional tax.
Pensions and Annuities
1. Rely on IRS Publication 505 for calculations and variables for pensions and annuities. A traditional individual retirement arrangement (IRA), pension plan, life insurance annuity or stock bonus plan distribution requires withholding or estimated tax payments. The IRS taxes interest only on Roth IRAs and other Roth withdrawals. If you expect to owe more than $1,000 in federal income taxes after withholding, avoid penalties by paying quarterly estimated tax payments. Alternatively, increase withholding at your employment by completion of Form W-4 with few allowances or additional tax withheld.
2. Estimate taxes owed for the current year with the help of your tax return from the previous year. Use the estimated tax worksheet in Publication 505 to determine estimated AGI.
3. Reduce your AGI by the standard deduction and exemptions. If you qualify for tax credits, reduce the AGI by any tax credits.
4. Use tax tables for the current year to determine estimated taxes. Divide the total tax owed by four and submit the estimated taxes with a Form 1040ES voucher. The IRS requires payment of estimated taxes the first working day following March 14, June 14, September 14 and January 14.
- Use Form W-4V to have taxes taken from your Social Security check. You can request 7 percent, 10 percent, 15 percent or 25 percent withheld each month.
- If you overpay your estimated taxes, you can leave the overpayment on file with the IRS and use it for your estimated taxes the following year.
- Even if you receive Social Security retirement benefits, you must pay Federal Insurance Contributions Act taxes (FICA) taxes on your earned income. FICA taxes include Social Security and Medicare. Self-employed individuals and independent contractors pay 13.3 percent in 2011 -- employees pay 5.65 percent.
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