Withholding and Social Security Benefits

Many folks find, upon filing their income tax return, that a portion (often a significant portion¹, up to 85%) of their Social Security benefits are taxable.  Upon discovering this, it’s also often a surprise that, since the benefit is taxable, there hasn’t been enough tax withheld throughout the year. This not only requires you to pay up come April 15, but it can also cause a penalty for underpayment of tax to be applied.  This underpayment penalty is likely if the amount of underpayment is $1,000 or more. You need to adjust withholding.

There are many ways to deal with this situation – it’s not required that you withhold tax from each and every source of income, as long as you have the tax withheld or timely estimated payments are made, it doesn’t matter the source of the funds.  Listed below are four withholding methods to help make sure you don’t have an underpayment penalty.

Withholding Methods

Estimated Tax Payments. This method isn’t actually withholding, but it achieves the same purpose.  On April 15, June 15, September 15 and January 15, payments are made to the IRS, often in equal amounts.  In addition, any overpayments that you made in the previous year can be applied in place of any portion of the estimated payments you’ve calculated (more on that later).  It’s important that the estimated payments are made in relatively equal portions throughout the year, otherwise you may still be subject to an underpayment (or late payment) penalty based on the timeliness of your estimated payments. IRS expects you to have made payments throughout the year (if using estimated payment vouchers) that match up with your income. So in other words, it’s not enough to make one big estimated tax payment at the end of the year, you’ve got to spread it out.

Unless you use the next method, that is…

Withholding From an IRA Distribution. This method is a little-known way to deal with meeting the withholding requirements. Essentially, when you take a distribution from your IRA (or Qualified Retirement Plan such as a 401(k) plan), you have the option to have the custodian withhold taxes and report them to the IRS.  No matter if you take a single distribution or quarterly or monthly distributions, the withholding is counted as evenly distributed throughout the year – taking timeliness of the distribution and withholding out of the picture.  For more details on this method, read “IRA Trick – Eliminate Quarterly Estimated Tax Payments”.

Withholding From Your Other Income. You probably already know this, but you can have tax withheld from many other sources of income.  Pensions, annuities, part-time work, and the like, can all be set up with tax being withheld throughout the year.  This is accomplished by filling out a Form W-4 (Form W-4P for pensions). You can set the amount of withholding to literally any amount that makes sense for your situation.

Withholding From Your Social Security Benefit. Much the same as all of your other income, you can set up your Social Security payments to have tax withheld.  This is accomplished by filling out a Form W-4V, and selecting the percentage of your monthly benefit that you’d like to have withheld. You can choose from 7%, 10%, 15% or 25% to be withheld.  You can find Form W-4V at the IRS website or by calling 800-829-3676.

How much should you have withheld?  Of course, that answer is going to be different for each person.  It’s determined by how much tax you are assessed, how much withholding you have from other sources, and the shortfall in withheld (or estimated payment) tax.  You can get the details on how to calculate the proper amount of withholding or estimated tax payments in the article “Understanding the Underpayment Penalty and How to Avoid It”.

¹ For more information on how much of your Social Security Benefit will be taxable, read “Taxation of Social Security Benefits”.