How To Change Tax Withholdings in Retirement

Taxes. Yuck! Our founders fought for “No taxation without representation!”. We won. But what we won was “Taxation WITH representation” which sometimes seems like not that great of a prize, frankly. Regardless, we’re stuck with the system. Government makes us figure out how much we owe them (they won’t actually tell us what we owe unless we’re wrong), and if you are wrong, they’ll make you pay extra. Then they take all that money and use it on stuff we don’t agree with. Alas, such is life.

Most of us don’t agree with the system, but we accept it as a necessary evil, and just want to limit the headache to as minimal as possible and get on with our day. In retirement, that typically means we want to have the right amount of taxes withheld each month from our annuity checks, so that we aren’t blindsided by some huge amount when we hit that “calculate” button on TurboTax.

But many of us are blindsided by an unexpected bill.

“How can this be? I filled out that stupid W-4P!!”

There are many reasons. You could have filled it out incorrectly (still very common even with my article). Or you or your spouse could have made more money than you anticipated when you filled the form out. Regardless, you don’t want to go through this again next year, so how can we rectify this?

Let’s talk about it.

Step One: Correctly complete W-4P prior to retirement

Fill out the W-4P as correctly as possible. ANSWER WHAT IT ASKS! It doesn’t matter if it doesn’t make sense to you. You get into trouble when you override what the question asks because you start to apply logic to a government form.

For example, the form asks you what your spouse will earn, and requests that you put that down. If you do exactly that, you’re probably ok. What happens is many people will say, “Well, I probably don’t need to put that amount down because she has taxes taken out of her check at her job.” So what?! That’s not what it’s asking. But you’re like, “Why should I include what she makes? Wouldn’t that mean they’re taking her taxes out of MY check too? That doesn’t seem right!”

Let me give you a really absurd example to make this clearer. Let’s assume you are a single person that has 20 different jobs in one year. (Not likely, but bear with me.). And let’s assume that you only make $10k in each one of those jobs. Got it? 20 jobs at $10,000 each.

When you fill out a W-4 for each one of those jobs, that job will only think you work that one job, if you don’t include all the others. So what will happen? Well, if you only make $10k in a year, then you won’t need to have any tax withheld since you won’t owe any taxes. And that HR department thinks you only make $10k a year.

But wait a second, you don’t make $10k, you make $200k!!! But how is any employing HR at any of your jobs going to know that they should withhold taxes from your check if they were never informed about any of the other jobs?? They won’t know. And they won’t withhold taxes. And you’ll end up owing a ton at the end of the year. And penalties. And you’ll be upset that your job didn’t withhold anything. And it wasn’t their fault.

Now, take the same example and say this guy is married. And his wife has a bunch of jobs. And she does the same thing. Well, now the problem is even amplified since you’re not linking all of the jobs together.

That is EXACTLY what happens with your W-4P when you don’t include what they are asking for. They need to know roughly what earned income your household is going to have so that they can roughly estimate what taxes you owe. Having money withheld based on a 10% bracket when you’re really in the 22% bracket with your wife’s income is going to cause problems.

Fill out the W-4P with the questions they ask, regardless of how much it doesn’t make sense to you. If you want to push back on this, please hire a CPA and do what they say.

Step Two: Adjust to correct things

It might be unlikely that everything works out EXACTLY the way it should the first year in retirement. You may not know how much money you’re going to make at your next job. You might have screwed up the W-4P. Your spouse may quit working. OPM may have made a mistake. You may have started pulling money out of TSP that increased your tax rate. Lots of reasons you have to adjust. Here’s how.

Each of you upon retirement will have an OPM self-service account.

This is the link:

Services Online

When you log onto your account, you will have options to change various things. This should be similar to what you have now (pre-retirement) if you have MyPay or NFC/EPP type accounts where you perform some self-service actions, like raise your TSP contributions, for example.

Here’s what your OPM Services Page will look like when you log in:

If you click on the Federal Tax Withholdings on the left (highlighted above), it will take you to a screen where you can complete new W-4P information to adjust your withholdings.

You have the ability to change it. By clicking “CHANGE.” That will prompt this screen to come up:

You can go in on the above screen and alter anything you need to so that your withholdings more closely approximate what you’ll actually owe in taxes for the year.

That’s Federal—now what about State taxes?

If you live in a state that taxes your federal retirement, you can also adjust that. This is both simpler and more complicated. Simpler in that you don’t have to fill out a form, you just give them a specific dollar amount. More complicated because how in the world do you come up with the correct specific dollar amount? Trial and error is one way. That’s suboptimal. Hiring a CPA is the preferred way.

Here is a screenshot of my account. I have $350 a month withheld from my retirement for Indiana taxes. I recently bumped this up to $350 from $300 as you can see. You will simply put the amount you want withheld and what state you want it to go to. Easy day.

This is the HOW of changing it. But what does one do to make sure what exact change to make in the first place? Well, again, you have 2 choices: guess and then adjust on a trial-and-error basis, or hire a CPA, or someone else knowledgeable enough to help you make sure you are having an appropriate amount withheld from your retirement check.

Manage your expectations. If you do not consult a professional prior to retirement, and if you choose to put whatever you want down on the W-4P even if you don’t understand it, please do not get upset when your withholdings are off wildly, and you owe $10,000 like some people called me this tax season to report.

SUMMARY

Taxes are difficult at any time, but they are more difficult in retirement. There are several reasons for this. One is the system you have been used to for your entire adult life doesn’t exist anymore: The “Married-2” or “Single-3” or “Married - 0 ”. That was done away with several years ago. The new system is more complicated. There is more work on your end to help determine what taxes should be withheld.

Use this article in conjunction with the other, W-4P Article HERE. And together, you should be able to come out relatively unscathed. As always, I would prefer you hire a CPA to assist you.