In this segment of the Motley Fool Answers podcast, Alison Southwick, Robert Brokamp, and special guest Ross Anderson from Motley Fool Wealth Management give some advice to a fan who is not quite ready to retire but is on the glide path in. But going from having most of your tax payment dealt with automatically via your W-2 to the situation when you're living off Social Security, retirement account withdrawals, and your investments mean learning a different set of IRS-related strategies.
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A full transcript follows the video.
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This video was recorded on Nov. 7, 2017.
Alison Southwick: Our next question comes from Tony. "I'm in my late 50s and have lived most of my working life as a W-2 employee. As I begin to think about retirement, I was wondering how the government would take their cut. How do you go about paying taxes on the distribution from an IRA? Do you pay it all the following April, or does the IRS want their money quarterly? And what about the portion of Social Security that is taxable? Do they take it out of the money they send you or are you left to pay it with your tax return?"
Robert Brokamp: This is one of those things that you have to get used to once you go from working to being a retiree, because if you're working (by a W-2 employee, he means he's working for somebody else), you're used to the taxes being taken out of your paycheck, and then you just hope it all squares up on April 15 of the following year. As a retiree, you are now responsible for paying your taxes quarterly, and if you don't pay enough, you'll have to pay a penalty once you file your taxes come the following April.
So, it's a little different depending on how you do it. With a traditional IRA, the custodian is required to withhold 10% and send it to the government. Now you can tell the custodian [that you] want more held out or I want nothing withheld, but they're going to take that 10%. Social Security won't automatically keep anything. You could ask them to withhold a certain amount, but it's only certain percentages, so you can only request 7%, 10%, 15%, or 25% and it can't be like $1 amount, but that's how they do it with Social Security.
And if you are selling stuff in your regular taxable account and getting dividends, interest, and capital gains those aren't withheld, so you have to do that calculating on your own. It is something you have to get used to as a retiree. I definitely think that for the first couple of years of retirement -- if you're not used to doing quarterly taxes -- you get the help of an accountant just to keep you set up.
Ross Anderson: Yeah, definitely, you can have a tendency not to want to take more out of the IRAs, because you get the full amount, and not do the withholding if you can, or do the lowest amount of withholding. I think that's a mistake. I would try and withhold directly on the withdrawals so that you're not getting a huge cash flow crunch later that you weren't expecting.
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