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A podcast designed to help retirees and those nearing retirement navigate finances and life planning with expert insights from financial advisor Trevor Lawson. Tune in for practical strategies and inspiring ideas to ensure your retirement years are purposeful, fulfilling, and truly your best chapter yet.
*Securities and investment advisory services offered through Osaic Wealth, Inc. member FINRA/SIPC. Osaic Wealth is separately owned and other entities and/or marketing names, products or services referenced here are independent of Osaic Wealth. Branch phone: 919-546-0400.
Trevor Lawson: [00:00:00] Welcome to The Retirement With and On Purpose Podcast. I'm your host, Trevor Lawson, and this show is all about helping you not just reach retirement. But truly thrive in it. You've put in the work. Now let's make sure you can enjoy every moment to the fullest.
Today's episode is likely top of mind for many of you as we are in the throes of tax season. We're gonna be talking about estimated taxes and why they become such a pain and ways to avoid the costly penalties for not making estimated taxes, estimated tax payments throughout the year. So the inspiration for today's episode comes from an article in The Wall Street Journal by Laura Saunders.
So I'll be quoting her, uh, rather frequently today. I think you'll find this [00:01:00] episode very pertinent as we make our way through and out of tax season and look for ways to improve next year's taxable outcome. So quoting here, wanna lower. Income tax bill. Check whether you're one of millions of Americans who are paying billions of dollars in late penalties, uncle Sam, if so, there are moves you can make to avoid or reduce them.
That's what we're gonna talk about today. These penalties are for underpayments of estimated taxes, which are line 38 of form 10 40. So this year when you get your taxes back, if you go to Form 10 40 and look at line 38. You'll be able to tell whether or not you were a victim of having to pay a penalty for not making estimated tax payments.
Most of these payments are on income that doesn't have taxes with withheld. Unlike employee pay, recipients of non withholding income include investors, retirees, business owners, and gig [00:02:00] workers. So I see a this a lot in my personal practice. A lot of my clients will retire and then they'll go work in a a, a passion job or perhaps start a business, and their income is now 10 99.
Self-employment income. And taxes are not being withheld. So these estimated tax penalties do start to really rear their head. Estimated tax penalties have surged recently. Such penalties reported by filers earning between 200,500, a hundred thousand, were about 1.3 billion for 2024 or triple the 2021 amount.
So these penalties have gone up tremendously over the past five years, and you'll find out why here in just a second. So here, here's the background. Quoting again. US tax law requires filers not only to pay their taxes, but to pay them on time. Since World War II when lawmakers expanded the income tax and instituted paycheck [00:03:00] withholding employees have had taxes sent directly to the IRS from wages to prevent gaming the system.
People with income not covered by withholding such as from investments or self-employment. We're required to pay estimated taxes on each quarter's. Income filers who fall short often owe an interest based penalty on the underpayment for the quarter. Again, the people that are gonna be most likely impacted by this tax underpayment are those that are self-employed or those that have investments where they're getting a 10 99 every year on those investments and.
Taxes are not being, being withheld or we've, we've just had a very good year in the market. The 10 99 has generated, and as a result of the earnings, you're gonna owe more taxes than usual. As an example, so if an investor has a $10,000 capital gain in February and waits until December to pay taxes on it, he or she could [00:04:00] owe an underpayment penalty for three quarters.
For all of 2025 and the first quarter of 2026, the rate on quarterly underpayments has been 7%. This is dropping to 6% in April. However, it's a lot higher than the 3% rate that was in place in 2021, so the rate is essentially doubled since 2021, which is why these underpayment penalties are becoming much more noticeable for tax filers.
Bottom line here. We need to know the fundamentals and how to avoid this. So filers who owe a thousand dollars or more of tax normally must pay 90% of their tax bill for the current year long before the April 15th deadline. To avoid these penalties, they can pay through withholding quarterly estimated taxes or both.
If you've got the opportunity to have more withheld, um, through an income source, you can, you can. Make that arrangement. Or you can [00:05:00] have your accountant, or if you file your taxes yourself, you can go direct to the IRS website, but you can make quarterly tax payments to help avoid that, that penalty for taxes paid through withholding the 90% threshold is a safe harbor that can prevent penalties, even if income is uneven.
So let's expand here on the safe harbors another safe harbor. Protect spoilers who pay a hundred percent of their prior year tax by the deadline. If income is 150,000 or less, or 110,000, if it's more, so if your income is 150,000 or less, if you pay a hundred percent of last year's taxes, your're in the clear.
If your income is more than that, then you've gotta pay 110%. Be careful to deflect penalties. Safe harbor amounts should be paid quarterly in equal installments. So that's, that's key. Uh, making these quarterly payments, they've gotta be done on a quarterly basis and made in equal installments. If a filer [00:06:00] pays all the prior year tax in the third and fourth quarter, penalties would likely apply.
So a lot of clients that are self-employed. You know, perhaps work is seasonal. They earn more in the third and fourth quarter just based on the nature of their business. If they are not making quarterly tax payments, you're likely gonna see a penalty reflected on, on your return. If that's the case, there are ways to fight underserved penalties.
So the IRS's computer computers can impose unwarranted penalties because they treat income as if it's earned. Equally throughout the year. So say that someone does a Roth IRA conversion or receives large fund payouts in the fourth quarter and pays the correct tax at that time, the system will likely assume the income was earned equally during the year, while tax was paid only in the fourth quarter and impose a penalty.
So this is very prevalent right now with Roth conversions becoming sort [00:07:00] of the, the topic de jour. A lot of people are exploring those and how they. Can, can be applied to their own retirement situation. So if you are one of those that's doing a Roth conversion every year, I would, I would certainly look to see if you are being penalized for not.
Not making tax payments throughout the year. The IRS will typically waive estimated tax penalties for many filers who recently retired or became disabled, among, among other things, to request a waiver. And for those doing Roth conversions, it's also worth requesting a RA waiver. Follow the instructions on form 2210.
So form 2210 on the IRS website is where you'd go to, um, request a, a waiver and fight underserved penalties. So in, in closing here, there's ways to look for withholding and, and avoid these penalties altogether. Many filers, especially retirees, have income that qualifies for withholding as well as income that doesn't taxable withdrawals from IRAs and [00:08:00] similar plans, pensions, social security, all of those employee bonuses are eligible for withholding, so we could adjust our withholdings there.
To, uh, ensure we're paying our, our required tax liability. Such income there has a great benefit because the law considers taxes withheld to come in evenly throughout the year, even though it doesn't. Um, as a result, quoting, some investors don't pay an estimated tax during the year. Instead, they make a taxable IRA withdrawal late in the year when income is known.
This way, they don't have, this way. They have enough tax withheld to cover at least 90% of what they'll owe sidestepping penalties. So let me rephrase that. So a lot of retirees who are taking money out of a taxable account like an IRA or 401k may at the end of the year take a one time withdrawal and have the bulk of that withdrawal withheld for tax [00:09:00] purposes.
And by doing that, that can, um. Help cover the tax liability from the year. But again, the IRS treats that amount having been earned equally throughout the year. And so it, it does cover you from the, the tax penalty standpoint. So. In closing here, I recommend after getting your tax return back this year to look at line 38 of your Form 10 40.
See if you are having to pay penalties for tax underpayments throughout the year. And if so, refer to the article here in the show notes that I've quoted throughout today's conversation and consider reaching out to your financial, professional or accountant for ways to avoid that penalty if applicable going forward.
As always, thank you for your time and I'll look forward to being with you again soon. Take care.
Thanks for tuning in to The Retirement With and On Purpose podcast. I hope you're walking away with new ideas [00:10:00] and a fresh perspective on how to make the most of your retirement journey. And remember, retirement isn't the end. It's your time to live with purpose. Until next time, I'm Trevor Lawson. Here's to a fulfilling and thriving retirement.