Did you start receiving your railroad retirement annuity before the age of 62? If so, you may need to increase your tax withholding when you turn 62. Why? This insight will explain….
As a railroad retiree approaching or turning 62, you’ve probably spent some time considering what your retirement benefits will look like. Railroad Retirement benefits are unique, but they still come with tax considerations—many retirees overlook this.
One common issue is taxes, specifically tax withholding. If you don’t adjust your withholding, you could face an unexpected tax bill when April rolls around.
Let’s dive into why increasing tax withholding at age 62 could be essential for railroad retirees and how you can stay ahead of any surprises.
Understanding Railroad Retirement Benefits
The Railroad Retirement Board (RRB) oversees two tiers of benefits for retirees: Tier I and Tier II. These benefits differ in both how they’re calculated and taxed.
We have covered Tier 1 and Tier 2 extensively on myrairoadretirement.com, and will provide an overview here.
Tier I vs. Tier II Benefits
Tier I is the equivalent of Social Security for railroad employees, meaning it’s based on your earnings and work history. Just like Social Security, these benefits are taxable if your income exceeds certain thresholds.
Tier II, however, acts more like a pension, providing additional income beyond what Tier I offers. One of the common misconceptions about railroad retirement is that benefits are fully exempt from taxes—similar to some state pensions.
Unfortunately, that’s not the case. Taxes apply to these benefits, especially if you have other sources of income.
Taxation Rules for Railroad Retirement
Your Railroad Retirement benefits could be taxed at both the federal and state levels, depending on where you live and your overall income.
Federal Taxes on Railroad Retirement Benefits
For federal taxes, Tier I is taxed similarly to Social Security benefits. If you have income beyond your Railroad Retirement benefits—such as from a pension, 401(k), or other investments—you might exceed the IRS’s income threshold, which could result in a portion of your Tier I benefits being taxed.
IRS form W-4P must be filed with the Railroad Retirement Board. IRS form W-4P is a form filed for the recipients of pensions, and annuities.
If form W-4P is not filed; then, the Railroad Retirement Board is required by law to initiate the mandatory citizen tax withholding.
Tier II: Contributory Amount
Tier II benefits are a little different. The IRS treats them as a pension, so they’re fully taxable from the get-go. That means no matter how much income you have, expect to pay federal taxes on your Tier II benefits.
For example, a retiree thought only Tier I was taxable because it mirrored Social Security. However, after explaining the difference, they realized they were under-withholding their Tier II benefits, which led to a larger tax bill than expected.
State Taxes: A Wild Card
It’s also important to consider state taxes. Some states don’t tax Railroad Retirement benefits, while others tax them fully. If you’ve moved states since retiring, it’s worth checking the tax rules in your new state to see if you need to withhold more.
And if you moved out of the country (U.S. 50 states) permanently you will need to submit form RRB-1001, Nonresident Questionnaire. Without this questionnaire the RRB will assume you are a Non Resident Alien and apply the 30% tax withholding to annuity payments.
Key Life Events at Age 62 That Impact Tax Withholding
Turning 62 is a major milestone for railroad retirees. You become eligible for Railroad Retirement benefits (Or you are 60/30: 60 years of age and 30 years of railroad service), which is fantastic. However, this also means your tax situation may change.
Early Retirement and Spousal Benefits
At 62, you can begin drawing on your Railroad Retirement benefits, and if you’re married, your spouse can also be eligible for spousal benefits. This is great for your household income, but it also means more taxable income. Many retirees don’t consider this “extra” income when determining how much to withhold for taxes.
Other Income Sources
By 62, many retirees have multiple streams of income—pensions, investment accounts, or even part-time jobs. All of these sources count toward your total taxable income and can push you into a higher tax bracket.
This extra income might trigger taxes on your Tier I benefits or bump you into a bracket where your Tier II benefits are taxed at a higher rate. Let’s consider an example.
A couple who didn’t expect their part-time income from consulting gigs to push them into a higher tax bracket. But by the end of the year, they found themselves owing significantly more in taxes because their combined income triggered taxes on their Tier I benefits.
Reasons to Increase Tax Withholding at 62
At age 62 the manner in which tier 1 benefits are taxed changes from private pension status to a split between Tier 1 (the social security equivalent benefit) and Tier 2 (the non social security equivalent benefit).
What this means to you is your tax withholding will automatically decrease. And this decrease can be substantial.
So why should you consider increasing your tax withholding when you turn 62? Here are a few key reasons:
Avoid Underpayment Penalties
If you don’t withhold enough from your Railroad Retirement benefits, you could owe a hefty amount come tax season. Worse, you might face underpayment penalties from the IRS if you fall short of their minimum withholding requirements.
No one likes penalties, especially when they can be avoided by simply adjusting your withholding.
Manage Additional Income Sources
As we mentioned, extra income from pensions, IRAs, 401(k)s, or part-time work can increase your taxable income. If you don’t account for these sources when determining your tax withholding, you could be in for a shock come April.
Change in Filing Status
Life events, such as marriage or the death of a spouse, can drastically change your tax situation. If you’ve recently remarried, or if your spouse has passed away, your filing status and income could change.
This change might impact how much of your Railroad Retirement benefits are taxable. It’s always a good idea to review your withholding after such events to avoid any surprises.
Estimating the Correct Tax Withholding
Once you’ve determined that you might need to increase your withholding, the next step is figuring out how much more to withhold.
IRS Tools and Professional Help
You can use the IRS’s tax withholding estimator to help calculate how much you should withhold from your benefits. Additionally, the Railroad Retirement Board (RRB) allows you to adjust your withholding by submitting IRS Form W-4V.
On this form, you can elect to have various amounts your Railroad Retirement benefits withheld for federal taxes.
When I first started working with retirees, I’d recommended we review their withholding annually, especially as they approached key ages like 62 or 70.
Over time, I’ve seen that retirees who stay on top of their withholding are much more financially secure in retirement.
Consulting a Tax Professional
Given the complexity of taxes on Railroad Retirement benefits, it can be helpful to speak with a financial planner and/or tax professional. They can help you estimate the correct amount to withhold based on your unique situation, including other sources of income and your overall tax strategy.
How to Adjust Your Withholding
Once you’ve figured out how much more to withhold, adjusting your withholding is relatively simple.
Adjusting Withholding from RRB Payments
The quickest way to adjust your withholding is by submitting Form W-4V to the Railroad Retirement Board. You’ll indicate the percentage you’d like withheld and submit it to the RRB.
It’s essential to review your withholding regularly, especially if your financial situation changes or you expect additional income.
Avoiding Common Mistakes
One common mistake I’ve seen retirees make is not adjusting their withholding after a significant life event, like the start of benefits at age 62 or a change in income.
Another mistake is underestimating how much they need to withhold, leading to a larger-than-expected tax bill. By staying proactive, you can avoid these pitfalls.
Special Considerations for Retirees Aged 62-80
For railroad retirees between 62 and 80, there are a few additional tax considerations to keep in mind.
Required Minimum Distributions (RMDs)
If you have retirement accounts like IRAs or 401(k)s, you’ll need to start taking Required Minimum Distributions (RMDs) once you turn 73 (if you are 72 after Dec. 31st, 2022).
These distributions are taxable and could push you into a higher tax bracket, which means you may need to increase your withholding at that time.
Medicare Premiums and Income
Higher income can also affect your Medicare premiums. If your income exceeds a certain threshold, you’ll have to pay higher premiums through the Income-Related Monthly Adjustment Amount (IRMAA).
Keep this in mind when planning your tax withholding, as your adjusted gross income (AGI) from your Railroad Retirement benefits and other sources will determine whether you pay higher premiums.
Conclusion
Turning 62 and entering retirement is an exciting time, but it’s also a time to be vigilant about your tax situation. Increasing your tax withholding now can help you avoid penalties, manage your income more effectively, and prevent any unpleasant surprises when tax season rolls around.
This insight gets deeper into taxes with examples; however, the information provided is for education and understanding. You will need to seek the advice of a tax professional for your particular situation.
By staying proactive, adjusting your withholding, and seeking professional guidance when needed, you can enjoy your Railroad Retirement years with peace of mind.
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