Taxes in Year 1 of Retirement

So here's what I learned doing a deep dive on this on a day off from work yesterday.

No, having paid some tax via withholding doesn't exempt me from needing to hit the quarterly payment percentage targets. My misunderstanding sprang from a misunderstanding of how the IRS by default views the timing of income.

By default, the IRS views income as being evenly distributed across the whole year. If I have income of $10K in Q1 and income of $140K in Q4, the IRS sees that $150K income for the year and they want, in each quarter, a payment of 25% of the required payment** on the $150K.

**The required payment being enough to reach the safe harbor which is the smaller of 90% of the current year's tax obligation or 100% (110% depending on AGI) of the prior year's tax obligation.

If you were to pay in Q1 100% of the tax on only the $10K income received in that quarter, you'll have an underpayment penalty for the year because the Q1 payment is less than 25% of the required payment on $150K income for the year.

Withholding makes avoiding an underpayment penalty easier as withholding from a paycheck or from an IRA distribution are by default distributed evenly across all quarters.

I keep mentioning by default. You can use form 2210 to apply withholding to the quarter in which it was withheld (Box D) and to instruct the IRS not to evenly distribute income across the whole year (schedule AI). These options can help to avoid or reduce an underpayment penalty.

I retired a few years ago. I worked until April, then ejected after bonuses were paid.

Withholding is always considered timely, so I adjusted withholding from my paycheck to cover other forecast income for the rest of the year.

Going forward, I have been doing a Roth conversion in late December with State & Federal withholding to cover my tax obligations. I then do a "60 day rollover" transaction to replace the withheld funds to make the Roth "whole".

I had assumed that I would start doing quarterly payments, but just doing withholding from a Roth conversion is so easy and convenient that I don't see any reason to switch to quarterly payments.

The only mild inconvenience is that my brokerage does not allow me to do it online, I have to call and walk the CSR though it. The first time, they were confused at the withholding higher than they expected, then super confused by the "60 day rollover" and had to put me on while they consulted with higher level support.

They must have written a FAQ for the CSRs because the second year I did it, the CSR was a little hesitant, but I said "I did this last year, can you review my call from last year?" I heard typing for a min or two and then she explained back to me exactly what I was asking for and why. I confirmed and the entire call took no more than 10 mins.

I don’t have an answer for this but nice strategy on the Roth conversions… I looked this up and I think it is something I will do throughout my 50s

I’m going through that this year, so I’ll let you know.

While this doesn't apply to me, I would be interested to know. I went back and looked at my tax transcripts for the year before, of, and after my last year of W-2 employment, and the only transaction that I see related to the W-2 withholding always applies to the account on the tax filing deadline. Which is strange, since I think the employer remits the withheld amount to the IRS for each pay period (though I am not certain about that).