In this Episode of the Secure Your Retirement Podcast, Radon and Murs discuss the importance of understanding tax withholdings in retirement to avoid tax surprises. Unlike during your working years when taxes are automatically withheld from your paycheck, retirement requires a more strategic approach to managing taxes. To help navigate this complex terrain, they bring in Taylor Wolverton, a Certified Financial Planner and Enrolled Agent specializing in tax strategy. Taylor shares her expertise on how to adjust tax withholdings and make informed decisions to ensure smooth income flow during tax season.

Listen in to learn about how you can avoid unexpected tax bills or penalties by effectively managing your retirement tax withholdings. Taylor provides practical examples and shares real-life scenarios to demonstrate how different income sources, such as Social Security benefits, pensions, and investments, can impact your tax obligations. This episode is a must-listen for anyone looking to develop a robust retirement tax strategy and maintain financial peace of mind.

In this episode, find out:

• How to adjust your tax withholdings in retirement to avoid surprises and penalties.
• The impact of different income sources, including Social Security and pensions, on your tax obligations.
• Strategies for maintaining consistent cash flow and managing tax liabilities efficiently.
• Real-life examples and scenarios illustrating the importance of understanding tax withholdings.
• Tips on reviewing and adjusting tax withholdings annually to align with your changing financial situation.

Tweetable Quotes:

• "The power of understanding your withholdings is peace of mind—no surprises come tax time." — Radon Stancil
• "Adjusting withholdings isn't just a set-it-and-forget-it task; it's an annual review to ensure your tax strategy aligns with your retirement goals." — Taylor Wolverton, CFP, EA

Resources:

If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary video course, Four Steps to Secure Your Retirement!

To access the course, simply visit POMWealth.net/podcast.

Radon Stancil:

Welcome to this episode of Secure Your Retirement Podcast. We are very happy to have you with us today. We're talking about the exciting topic of making sure that our withholdings, our tax withholdings are calculated correct, and we're doing the right amount.

Now, this is one of those topics that Murs and I are not really that good at, wanting to make sure we go into all the details. So we brought on our tax expert Taylor Wolverton. So Taylor, thank you very much for coming on and chatting with us.

Taylor Wolverton:

Hello. Thank you.

Radon Stancil:

Taylor Wolverton:

Right. Mm-hmm.

Radon Stancil:

Then what are you projected... How many are you projected to do this year?

Taylor Wolverton:

This year we'll do at least 105.

Radon Stancil:

105. Think about this. If you're listening to this or watching it, either way you're doing it. That is where this rhythm of looking at things and just really understanding it. Imagine if you were going through 100 tax scenarios in a year, 80 last year, 85 last year, 105 this year. That's why Taylor is able to answer some of these questions for us so efficiently.

And this topic is something that we run into all the time. Sometimes people are not withholding enough, sometimes they're withholding way too much, and so it's frustrating for them. They're either getting a big check back or they owe some money at the end of the year. They don't really know. It makes whole tax scenario very apprehensive.

I'll tell this quick story and then Murs can give us the overview. Last year, the takeaway from one of our clients that came in and did their tax strategy meeting with Taylor was this... Oh, and by the way, Taylor told her that you need to do a little bit more withholding for her to not have to pay any money. And she says, "I have never closed out a year with this much peace of mind and comfort."

But that one thing, she said, "I can go now for the rest of this year and just not have to worry." And that's the power of understanding your withholding. So Murs, can you give us a little overview of what we're going to discuss today?

Murs Tariq:

Yeah, and to piggyback on that, Radon, I think a lot of people when it comes to taxes and filing their taxes, they just expect to be surprised. They expect to be surprised on, "I feel like I'm going to owe a lot this year." Or, "I feel like maybe I'll get a refund." And it's just always a surprise and waiting until the tax return has been filed in April to know what they owe or what they are going to get back and how big that surprise truly is.

So what's nice out of these tax strategy meetings that Taylor leads is that well, the surprise, the element is being taken out of it because by the end of that visit she's able to tell them with a really good a lot of data behind it to say, "Here's how we're going to shape up come April." There are no surprises anymore, which I think is really beneficial.

So on adjusting and talking about withholdings, let's talk about withholdings for a second. In that aspect of, well, when you're working and you're earning a salary, a lot of people are W2 type employees where their withholdings are automated for them. A certain amount is taken out of your paycheck every two weeks and you never really think about paying taxes until that tax time comes.

And so when you shift into retirement, withholdings is a whole different thing. Taxes are a whole different thing in that you got to be way more aware of how taxes are going to shape up for you. There's no employer anymore that is taking care of your withholdings and making adjustments and recommendations for you. It's all on how you set up your sources of income. And so today what we're going to talk through is, well, there's things we need to think about.

Take the person that retires in the middle of the year. Well, for a period of time, maybe five, six months of that time, they did have withholdings through their salary. The employer was handling it, but then they stopped earning income. But what they probably also did is maybe turn on Social Security or other sources of income are started withdrawing on some of their retirement assets.

And again, the employer's not helping you with that side of it. So turning on income, different types of income sources, IRAs are taxed one way, capital gains are taxed another. So security has a different taxation to it. So what Taylor does really well is puts it all together and say, "Okay, based off of this, here's my recommendation on how much we should withhold to breakeven come April of next year."

And so there's a lot of things to think through. "Is it our RMDs? Was there a large capital gain from selling real estate that year? Did we turn on various income sources?" And unfortunately, it's not always just, set it and forget it. It's something that we want to review every single year annually because income sources change, life changes, withdrawal amounts change.

And so it is something that could be simple, viewed simple in someone's mind as something that is a little bit complex that needs to be walked through every single year. So we're talking about adjusting withholdings. Taylor's got a couple scenarios she's going to walk us through. So Taylor, why don't you take it away?

Radon Stancil:

Murs Tariq:

Or Radon's going to walk us through here.

Radon Stancil:

We rehearsed this really good, Murs. All right, so just what Murs said though, Taylor, we did ask her, we said, "Hey, can you put together a couple of scenarios, redact the real names of the client?" But basically real life scenarios of what it is that she deals with as she goes through this 80 to 100 different plans every year.

And so I'm going to build up the scenario and then she's going to take us through the scenario. So here's the scenario. We named them John and Jane. We do have some Johns and we have some Janes, but we don't have any that couple John and Jane and they are starting their Social Security benefits.

But here's their overall situation. They retired a few years ago. They've been covering the majority of their living expenses with cash in the bank. So just out of their actual money in the bank, so not really creating any kind of a tax problem. But now they are decided that they do want to supplement their income with Social Security.

They're both 67, so they're at full retirement age. And so they're saying, "We're going to turn on that Social Security now." And they're going to have started it in January. Now that part probably is, we did embellish that a little bit just to make it super easy for the whole year to run. So we have them starting in January and they want to know, "Hey, how much should I withhold on my Social Security?"

Because when you do file for Social Security, you're able to say right on there, "I want to withhold taxes." But how much did I hold? And they want to make sure that they breakeven. They don't want to want to owe much, they don't really want to get a lot back. So we're putting this range in and around $500. So that's the setup of everything. And so now Taylor's going to take us through all the nitty-gritty.

Now I do want to tell you this and you can go ahead and share if you want, Taylor, your screen. Taylor is going to share her screen, so if you're listening to this on something like iTunes or you're listening to this on the website, you're not going to be able to see it, but I'm going to tell you how you can see it.

One, is you can go to Spotify. We've been encouraging people to go over to Spotify because at Spotify you can actually listen as well as watch it. And so this will actually have the video where you'll see all this detail. We're going to walk you through it verbally though.

And then the other option is we do put this on as a YouTube as well on YouTube as far as a video goes. So either place if you want to see these details because she's going to walk you through a lot of numbers, just feel free to go there and watch it. So all right, take it over there Taylor.

Taylor Wolverton:

Okay, so first thing we're going to talk about is John and Jane's sources of income. So what they have this year is what we're expecting is for them to receive $10,000 in interest and dividends combined. Jane also has a pension, this year it's going to be $40,000 for the entire year.

And then because they're both starting Social Security benefits, new, John's Social Security benefit this year is going to be $35,000 total. And then Jane's Social Security benefit is going to be $20,000 per year total. So combined Social Security benefits between the two of them, they're going to have about $55,000 in Social Security that they will receive this year.

And yeah, it is more realistic that our clients start Social Security part way through the year. So it's not actually January through December, which is a little bit more complicated. So yeah, just for simplicity, we're having them start Social Security January through December this year. So with all of their income sources combined this year, the total that we are expecting is for them to receive $105,000 in income.

The next thing that we have to determine is how much of that income is actually going to be taxable to John and Jane. So first source of income that we mentioned, they're $10,000 in interest in dividends, they are going to pay tax on that full amount of $10,000. Same for Jane's, $40,000 pension. She's going to pay tax on the full $40,000 that she receives.

Social Security is a unique source of income in the way that the other amount of income that you have available to you is what determines how much of your Social Security you pay tax on. So for John and Jane this year, they are going to pay tax on about 63% of their total Social Security benefit, which for them is going to be $34,475 out of their total $55,000 Social Security benefit.

So we add up their $10,000 interest in dividends, they're going to pay tax on the $40,000 pension and then the $34,000 amount of their Social Security that they're going to pay tax on. And our new total that we come to is $84,475. And then the last step before we figure out how much in tax that they're going to pay is to subtract out either the standard deduction or itemized deductions.

For John and Jane, we are going to assume that they take the standard deduction this year and whether you're over or under the age of 65 changes your standard deduction. John and Jane, they're both aged 67. So because of that, their standard deduction for this year is going to be $32,300.

And what that really means anytime we talk about a deduction in taxes is it's an amount of income that they don't have to pay tax on. So when I told John and Jane, "Your standard deduction is $32,300," what that really means they have $32,300 of income this year that they are not going to pay tax on. So we subtract that out from our total as well. And now that leaves us with taxable income of just over $52,000.

Radon Stancil:

Okay, so I want to interrupt you here for a second. So this is why I'm saying if you want to go watch this, all the numbers are on the screen right now. You can follow it right through. If you heard that whole thing she went through on Social Security and you're going, "Oh my goodness, why is it 63%?" And you want to know all that math, I just was going to tell you where you can go find it, you can go to episode 231.

Taylor Wolverton:

So what we're looking at on our screen here, if you're just listening to this, the first $23,200 of income you pay a 10% tax on. And then over $23,200 you pay a 12% tax on, which is where John and Jane fall into the range associated with the 12% tax bracket is $23,200 up to $94,300. So with John and Jane being at around $52,000, they're going to fall into what we would call the 12% marginal tax bracket.

But remember they're not paying tax on the same amount of tax on every single dollar of income. So the first $23,200 they're paying a 10% tax on, and then the next about $29,000 or so they're going to pay 12% tax on. So the total is their $52,000 that we determined is their taxable income.

So because we have these different portions of tax, we calculate what the total is going to be. And for John and Jane this year, based on that amount of income, the amount of federal tax that we would expect that they would owe is $5,797. So-

Murs Tariq:

Yeah, Taylor, I'm glad you made that-

Taylor Wolverton:

Yeah, go ahead.

Murs Tariq:

... distinction, because I think the tax scale is misunderstood and misrepresented quite a bit that someone could say, "Well, I'm in the 32% tax bracket." And there's a big distinction between what your marginal rate is and what we would call your effective rate, which is the average across the tiers that you ended up paying in.

Because to me, when I hear I'm in the 32% bracket, really what that means is, "well, you made good income to put you into this section of taxation, but not all dollars were taxed at 32%. So I'm glad you walked that through because I think it is a misunderstanding quite a bit.

Taylor Wolverton:

Yes, very true. Yeah, I think a lot of people probably pay less in tax than what they actually think because like we were saying, if John and Jane took that original $105,000 total that we talked about when we added up all of their income, they would probably put themselves in paying in the 22% marginal tax bracket.

Which is actually not true once we take into consideration the Social Security they're not paying tax on, their standard deduction they're not paying tax on, and then also remembering that you have to walk through each of the brackets and you're paying different rates on different amounts of income. So yeah, that's a fun conversation to have.

Okay, so from here, John and Jane have a few different options. Option number one, they could choose to do nothing and at the time that they file their tax return, they'll have to pay the entire $5,797 in tax. They could do that if they wanted to.

One caution that I would give is that if you wait until the time you file your tax return to pay all of your taxes, it's possible that you could be subject to underpayment penalties in addition to that. So I don't usually make that recommendation. I don't want people to pay underpayment penalties unnecessarily.

So another option that John and Jane could choose to do is make estimated tax payments. Those are due quarterly. So four times throughout the year they would pay their tax. So for John and Jane, if we just split up their about $5,800 in tax four times, so they're paying an amount each quarter, they'd be paying about $1,450 each quarter. So they could do that, if they wanted to.

But for John and Jane, what we are going to do is the third option where we're going to set up withholdings on their Social Security benefits. So for Social Security specifically, you have four different options for what you can choose to have withheld from your benefits. You can do 7%, 10%, 12%, or 22%.

So for John and Jane, what I would recommend for their situation is that John withhold 12% from his benefits, which again, that's $35,000 per year is his total benefit. And then for Jane with her $20,000 per year in Social Security benefits, I'm going to recommend that she withhold 7%.

So with John adding 12% in withholdings on Social Security and Jane adding 7% in withholdings, they are going to start paying that federal tax throughout the year. Each time they get a Social Security benefit, a portion of it is sent to the IRS and for the total year they are going to have withheld $5,600.

So if they file their tax return, they owe about $5,800 in tax. They have already had withheld throughout the year $5,600 in tax, that means there's going to be a remaining payment due of around $200 at the time that they file their tax return.

Radon Stancil:

Just one little thing on this, and we on purpose here, didn't put in state specific withholding, and this podcast is listened to all over the country. So depending upon where you are and what state you are, there's going to be different tax rates. So we do have a lot of clients in North Carolina, but we have clients all over the country.

So you would have to do a little bit of calculation and consideration on what you might want to withhold for state tax, but the concept of what Taylor's walking through is pretty much the same. I mean, you could live in a state that has no income tax. Well that's one thing, you don't have to worry about it if you live in a state like North Carolina, we do have a state tax. So you'd have to do the calculations and say, "Hey, well how much do I need to withhold on my state?" So that would just be something individualized that we have to do.

Taylor Wolverton:

Yes.

Radon Stancil:

Is that all you got on that scenario there, Taylor?

Taylor Wolverton:

Yes, that is. One other thing about the state tax too, that I would say is some states also don't even tax Social Security. North Carolina is one of those states. The state that I live in, Utah, does tax Social Security. So that's also one variation that depends on where you live and how your state treats Social Security benefits once those do begin for you.

Murs Tariq:

Right. All right. So that was a scenario around John and Jane starting Social Security and navigating the how to pay tax on it. The ultimate recommendation on our side was do withholdings. And if you think about it, you've been doing withholdings all your life through how you've earned income. So it just makes it easy, it makes it simple, it makes it automatic. So you are not surprised.

Getting the numbers right is important. That's what Taylor helps with and the right percentages, but it makes it something you don't ever have to worry about if it's already being done every paycheck that you get from Social Security.

Okay, we're going to transition now to another scenario. This one is still around tax withholdings and it's about Bob and Sue. Bob and Sue have been retired for a few years and it's Bob's first full year of retirement. They're both aged 71 and they like getting a return. When it comes tax time they like getting a refund, but nothing substantial around $2,000.

So what Taylor's going to walk us through is their scenario, and ultimately this is a reduction of tax withholdings rather than adding on additional tax withholdings.

Taylor Wolverton:

Yes. Yeah. In Bob and Sue's situation, because this year is Bob's first full year of being retired, in previous years they had more income from Bob's wages, which was pushing them into a higher tax bracket, which means that they were paying more in tax.

So they had withholding set up on other sources of income that they had available to them to fit that higher tax bracket that they were in. But now Bob doesn't have wages this year, which means they're going to fall down into a lower tax bracket and pay less tax. So we're going to reduce their withholdings to adjust for that difference this year.

So again, just like with the previous scenario, we're starting with the total income that they have available to them. So for their interest in dividends, we're going to expect around $10,000 this year. They also have some investment income from selling stock this year that's going to be around $15,000.

And they're also taking distributions from one of their annuities, which is an IRA. So that's going to be $50,000 total in IRA distributions this year. And they both have Social Security benefits. So Sue's Social Security benefit this year is $37,000 and Bob's is $25,000. So total across all sources of income that we're expecting this year, Bob and Sue are going to have $117,000 in income.

And then we're talking about how much of that income is going to be taxable to them. So again, their interest in dividends, we're going to expect all $10,000, they will pay tax on. Same with their $15,000 in investment income, they'll pay tax on the full $15,000 amount.

The IRA distributions are fully taxable as well. So that's another $50,000. And for their Social Security benefits, their total between Bob and Sue, they have $62,000 in total Social Security benefits. The most amount of Social Security that anyone will pay tax on is 85%.

So that's how Bob and Sue's situation comes out to. Their other sources of income are high enough that it puts them up to the top of the maximum amount that they'll pay tax on for Social Security. So 85% of their Social Security benefits is $52,700.

So total now taking into consideration that a portion of their Social Security benefits is not taxable, we have $127,700 of income. And then same standard deduction for them as well. They're both over the age of 65, which means that their standard deduction this year is $32,300, so they don't have to pay tax on that amount of income. We subtract that out and we are left with taxable income of $95,400.

And then for Bob and Sue, they have about $1,100 of income that is going to be pushed over into the 22% bracket. So they'll pay 22% on the last $1,100 of taxable income. So calculating the amount of income that they pay 10%, the amount they pay 12%, and the amount they pay 22% tax on their federal tax liability for this year, we are going to expect they will pay $11,094 in federal tax.

So like we mentioned before, they already have withholding set up on their sources of income. So in previous years they started withholding 22% from both of their Social Security benefits. That's the most you can choose to withhold from Social Security. So between the two of them, they will have already withheld $13,640 just from Social Security. They also set up a 15% federal withholding on their IRA distributions from their annuity.

So that's going to be another $7,500 in federal tax that they will have already had withheld. So with both of those withholdings from Social Security and the IRA distributions, if they don't make any changes, will have already withheld over $21,000 in federal tax. And if you remember, we just said that their federal tax liability that we're expecting is just barely over $11,000, so immediately we can see they're withholding too much.

So because of that the recommendation that I would make in Bob and Sue's situation is to decrease their withholdings on their Social Security benefits. For Bob, we're going to take it down from 22% to 12% in federal tax withholdings on his Social Security. And then for Sue's Social Security withholdings, we're going to take it down from 22% to 7%.

And then we're going to leave the withholdings that are on their IRA distributions from their annuity. So that was at 15%, that can stay the same. So now with this reduction in Social Security withholdings, really we're leaving the IRA the same. The total amount of federal tax that they will have withheld now due to that adjustment is going to be just over $13,000.

So if they owe $11,000 at the time they file their tax return, they, through their withholdings have withheld $13,000 in federal tax, they are going to get a refund of right around $2,000 at the time that they file their tax return, which is what they were targeting. So that's how we figure their situation.

The good thing for them too is, now that we're reducing the amount that they have withheld in Social Security benefits, it also means that rather than getting a huge $10,000 refund, which is what they were on track for, now they're going to be getting a higher amount of their Social Security benefits netted to them each month, so they have more cash flow for them throughout the month rather than getting $10,000 back at the time that they get their tax refund.

Radon Stancil:

Excellent. Well, now you know why we say that Taylor's our tax expert, because she goes through this so many times. While you may be listening to this or watching this and thinking, "Man, I still don't know that I completely got it," let's leave you with this. If you don't know, that's why you might want to go through a tax strategy meeting with Taylor because that'll help you go, "Okay, I understand exactly where my withholding should be at this point."

So anyway, if you are listening to this and you've got questions, maybe you would like to talk about something, feel free to go to our website, which is POMWealth.net. Go to the top right-hand corner, click on schedule call, and our calendar comes right up. We, Murs and I, will be on the phone with you for a few minutes. We'll direct you and try to figure out how we could get you lined up maybe with Taylor if that's where we need to go. But we'll walk you through exactly how to do that.

But thank you very much Taylor for coming on and preparing all this for us. Super helpful. I mean, even me going through it and I do this for a living as well, just going, "Okay, that makes more sense now. I'm seeing it." When you don't deal with the tax side of things as much as you do, it does help us to see this go through. So thank you very much and for everybody else, we'll talk to you again next Monday.