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Tax News You Can Use

IRS Form W-4R: Withholding from IRA and Qualified Plan Distributions

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Tax News You Can Use | For Professional Advisors

 

Jane G. Ditelberg

Jane G. Ditelberg

Director of Tax Planning, The Northern Trust Institute

Distributions from traditional IRAs and qualified plans are subject to federal income tax unless certain exceptions apply, such as for qualified charitable distributions (QCD). To facilitate the payment of the tax, the IRS mandates that the custodian, trustee or plan administrator (“payor”) withhold income tax from the distribution unless the taxpayer elects otherwise. For 2024, the IRS has issued a new form W-4R, making this an ideal time to review how the withholding works, and the options available to taxpayers receiving this type of distribution.

What is form W-4R?

The taxpayer files a form W-4R with the payor when opening an account and whenever they would like to change the amount of withholding (which can be as often as every time they take a distribution). If the form is not filed, the payor must withhold at the default withholding percentage. For this purpose, the distributions are divided into two categories: “eligible rollover distributions” and “other distributions.” Eligible rollover distributions are those that could be transferred to another qualified plan or IRA in a trustee-to-trustee transfer. Required minimum distributions may not be rolled over and do not fall into this category.

What are the withholding rules for eligible rollover distributions?

The general rule is that a payor must withhold 20% on each eligible rollover distribution that is paid to the account owner rather than directly to a permitted qualified plan or IRA. For these distributions, the recipient cannot elect to have less than 20% withheld, but may elect to have more than 20% withheld by filing a form W-4R. This is designed to encourage rollovers by trustee-to-trustee transfer rather than by distribution to the owner. In order to complete a rollover of the full amount, the taxpayer will need to use other funds to replace the amount withheld when funding the new account, and then claim a refund for the amount withheld.

What are the withholding rules for other distributions?

For distributions other than eligible rollover distributions, which includes all required minimum distributions, the default is 10% withholding. However, as long as the recipient is receiving the payment within the U.S., the account owner can elect to have withholding of any amount from 0% to 100%. For payments to recipients outside the U.S., the amount withheld cannot be less than 10%. The election is made on a form W-4R delivered to the payor prior to the distribution. Please note that if the individual is a non-resident alien or a foreign entity, form W-4R cannot be used.

Why would a taxpayer elect to withhold more or less than the required amount?

Penalties apply to taxpayers who do not, through a combination of withholding and estimated tax payments, pay sufficient tax (90% of current year’s tax or 100% of prior year’s tax) by the due date for each quarter. Since income tax rates in the U.S. go up to 37%, a 10% withholding may not cover a taxpayer’s obligations. On the other hand, taxpayers who have losses, deductions, and credits may have effective tax rates less than 10%, and may not need to have the full amount withheld. Withholding is treated as paid ratably across the entire year, so electing withholding from these distributions can be a helpful way to reduce the chance of a penalty.

For those taxpayers who make quarterly estimated tax payments, it is important to coordinate any withholding elections with your tax preparer so that you do not make estimates and withhold for the same sums. This can avoid overpayments.

Examples:

Example 1: McKenzie is age 65 and has a qualified plan with their employer with a value of $500,000. McKenzie is retiring this year and is no longer eligible to participate in the plan.

  • McKenzie opens an IRA at a financial institution and withdraws the entire balance of their plan account with the intention of transferring it to the IRA. In this case, because this is an eligible rollover distribution, the plan must withhold $100,000 in tax (20%), unless McKenzie files a form W-4R and elects to have more withheld.
  • Assuming McKenzie wants to roll over the entire $500,000, they will need to use the $400,000 they receive from the plan plus an additional $100,000 of other assets and will be able to claim a refund because the rollover was not taxable.
  • To avoid this withholding, McKenzie could instead do a direct trustee-to-trustee transfer from their qualified plan to the IRA.
  • If Avery plans to withdraw the RMD in pieces over time, they have the option to file a new W-4R for each distribution indicating the desired withholding amount for that payment.

Example 2: Avery is age 75 and the RMD for this year from their IRA is $100,000. Avery has several options.

  • Avery could direct that this amount be distributed to their favorite charity as a QCD. In that event, there would be no required withholding.
  • If Avery withdraws the Required Minimum Distribution (RMD) on their own, the default rule is that the IRA custodian must withhold $10,000 (i.e., 10%) in taxes from the payment. If they do nothing, this is the amount that will be withheld, but they also have the option to file a form W-4R and change the withholding amount. As long as Avery is in the U.S., the amount could be anywhere from 0% to 100%.
  • Avery believes their effective tax rate is 25%, taking into account all of their income, credits and deductions. Therefore, they could file a form W-4R and request that 25% be withheld from the distribution for taxes instead of 10%.
  • If Avery has already paid quarterly tax estimates based on income that includes the RMD, then they might elect to have 0% withheld from the distribution by filing a form W-4R with the payor.

Where can I find more information on withholding from IRA distributions?

Form W-4R and its instructions can be found here: https://www.irs.gov/pub/irs-pdf/fw4r.pdf

Additional information from the IRS is available in publication 590-B, available at: https://www.irs.gov/pub/irs-pdf/p590b.pdf For further questions, contact your tax preparer or your Northern Trust advisor.

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Disclosures

© 2024 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the U.S

This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.

The information contained herein, including any information regarding specific investment products or strategies, is provided for informational and/or illustrative purposes only, and is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any investment transaction, product or strategy. Past performance is no guarantee of future results. All material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.

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