A reader reached out with a question about interest the IRS charges on tax underpayments.

For the 2023 tax year, "Samuel" paid a larger estimated tax than was due to cover his tax obligation. But the year before, he underpaid, and as a result, he owes the government interest (a penalty) for the underpayment for the 2022 tax year.

Samuel's question really has to do with reciprocity and ultimately, fairness: "Will the IRS now pay us any interest on this overpayment? It seems only fair that if they can charge us interest or penalty on an underpayment, they should then pay us interest for using our overpayment for the year."

In Samuel's case, an overpayment followed an underpayment.

According to an IRS spokesperson, this type of situation "is no different than a wage-earner who overpays their taxes through withholding and gets a refund as a result of filing their 2023 return."

"Normally, a taxpayer won't receive interest on their refund, unless it takes a long time to process their return," the spokesperson said, adding, "That happened a lot during the pandemic, and largely for that reason, the IRS had to pay interest on a relatively large number of refunds."

There is a special provision for those who make estimated tax payments, according to the IRS spokesperson: "If you overpay your 2023 tax, instead of receiving a refund, you can choose to apply that overpayment to your 2024 estimated tax payments. If you file on time, your overpayment will count as an estimated tax payment made on April 15, 2024, regardless of when you would have received it, had you chosen that option."

The basis for how taxes are paid and penalties levied goes back to the "pay as you go" nature of the tax system, which was set by Congress, not the IRS. The Current Tax Payment Act of 1943, passed during World War II, called for withholding taxes from paychecks and paying those taxes to the government (tinyurl.com/38kk2c68).

As the IRS explains on its webpage "Pay As You Go, So You Won't Owe" (tinyurl.com/vzjy8fk2):

"This means that you need to pay most of your tax during the year, as you receive income, rather than paying at the end of the year. There are two ways to pay tax:

"[1] Withholding from your pay, your pension or certain government payments, such as Social Security.

"[2] Making quarterly estimated tax payments during the year.

"This will help you avoid a surprise tax bill when you file your return. You can also avoid interest or a penalty for paying too little tax during the year. Ordinarily, you can avoid this penalty by paying at least 90 percent of your tax during the year."

According to the IRS spokesperson, the tax penalty "is designed to encourage people who either don't have withholding, or don't have enough withholding, to make these payments, make them timely and make them at sufficient levels."

The IRS provides more details on its webpage "Underpayment of Estimated Tax by Individuals Penalty" (tinyurl.com/477e9y4s). Included is information on how the penalty is calculated, interest on the penalty (additional details on interest can be found at tinyurl.com/2b9nsuhn), and removing, reducing or disputing a penalty.

"Of course, as we all know, there are many practical problems with figuring and making estimated tax payments, but that's also why there are thresholds and exceptions in the law that are designed to ease the burden," the IRS spokesperson said, adding that "[t]axpayers can, and often do, vary their estimated tax payments throughout the year to accommodate fluctuations in income."

If you are new to paying estimated quarterly taxes, be sure to review the IRS webpage "Basics of estimated taxes for individuals" (tinyurl.com/3w9ekftz) and IRS Publication 505, "Tax Withholding and Estimated Tax" (tinyurl.com/3mwahezp). Also, if you live in a state that has a state income tax, you will want to review the state's instructions related to who is required to make estimated tax payments.

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Have you seen TV or direct mail ads for reverse mortgages? I'm going to guess that you have, especially recently, since the volume of mail ads has increased dramatically over the last few years.

The most common type of reverse mortgage is the home equity conversion mortgage, or HECM. Insured by the Federal Housing Administration, the program "enables you to withdraw a portion of your home's equity to use for home maintenance, repairs, or general living expenses," per the U.S. Department of Housing and Urban Development website (tinyurl.com/39fcd5n2).

According to the Consumer Financial Protection Bureau, the volume of reverse mortgage direct mail ads increased from 11 million ads per year in 2019 and 2020 to 44 million in 2021 and 48 million in 2022 (tinyurl.com/mrykhpys).

Who is the audience? Largely low- and middle-income households, with 74% of the direct mail ads going to age-62-or-older households with incomes below $75,000. A CFPB analysis of 2021 1-year American Community Survey data indicated that this demographic (age and income) represents 53% of U.S. households. According to U.S. Census Bureau, 78.9% of householders age 65 and older owned their own home as of the second quarter of 2023. (Source: Table 7, Homeownership Rates by Age of Householder, tinyurl.com/32dhy423.)

The ads go beyond acquiring a reverse mortgage. They are also directed to households that already have a reverse mortgage, with offers of refinancing, which raises a concern. About 51% of the ads that went to people in the West region were refinancing ads in 2021-2022.

Overall, about 84% of direct mail reverse mortgage ads went to people living in states in the South and West during 2021 and 2022, "where a somewhat higher share of older homeowners report difficulty making ends meet and difficulty making mortgage payments."

The CFPB cautions: "[T]he increase in ads for reverse mortgage refinances are concerning in that they suggest lenders may be targeting existing reverse mortgage borrowers for costly closing costs rather than providing them with a new product that reduces the effect of economic hardship."

The idea behind reverse mortgages is helping older homeowners with financial needs. However, "[t]ypically, a reverse mortgage is a more expensive product than other home loans. For some older adult homeowners, using their equity to avoid monthly mortgage payments is a tradeoff they are willing to accept," reports the CFPB. "For others, it's a product that jeopardizes their financial security and may prevent them from leaving their home to their heirs."

The CFPB goes further: "Although the intent of the HECM program is to meet the needs of older adult homeowners with lower incomes the data nevertheless suggests that reverse mortgage lenders are potentially targeting vulnerable populations with an expensive product that may not be best suited for their individual housing and financial needs" (tinyurl.com/mrykhpys).

While the recent CFPB study focused on direct mail ads, TV ads for reverse mortgages have been prevalent for some time. In a 2015 CFPB study, focus group participants "reported seeing television advertisements frequently, even several each day" (tinyurl.com/5f7kc4k9). The ads "frequently feature celebrity spokespeople."

However, none of the participants could read the fine print used in the TV ads. Many consumers "expressed surprise when shown a printed ad stating interest rates." Several participants believed that reverse mortgages were "provided by the government and that therefore repayment would not be required."

While reverse mortgages can create a safety net in the right cases, they can backfire in the wrong cases. As always, be prepared to do your homework before getting a reverse mortgage.

How? Here are some resources:

1. If you plan to do a reverse mortgage, participate in a required consumer information session given by a HUD-approved HECM counselor (tinyurl.com/33avv9ku).

2. The CFPB provides an overview of reverse mortgages at tinyurl.com/3456m2jc.

3. The Federal Deposit Insurance Corp. also offers information about reverse mortgages at tinyurl.com/5n6kz5rv.

A reverse mortgage may be the right decision for you, but be sure to do a deep dive into the details before you agree to one.

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I recently received a call from a reader with an interesting dilemma. "Meryl's" husband was about to retire. The couple had used a few traditional stockbrokers whom they enjoyed working with over the years. One of them proposed they purchase an investment that they didn't understand, a certain type of complex annuity.

They wanted to go ahead with the purchase based on the recommendation, but they weren't sure of what they would get in return for the investment. Where could they go for help? "And, oh, by the way," Meryl added, "we don't want to pay anything for advice."

Again, an interesting dilemma. If this had been a plain vanilla annuity that pays a lifelong income stream with no penalties or complexities, it would have been a different story. However, that was not the complex product that was shown to this couple.

My first suggestion was to go back to the broker to ask for disclosure documents and the contract. Then, ask the broker to review them, with a focus on helping the couple understand the very basics, such as:

-- Why are you recommending this particular product?

-- What else have you considered?

-- What will you get paid if I buy the product?

-- After I buy this product, what can I expect?

-- Can I take out money at any time?

-- Are there restrictions on when and how much I can take out?

-- Are there any penalties?

-- And, please show me where I can find the answers in the contract and disclosure documents.

By the way, if the broker doesn't want to tell you about his or her compensation for the sale, don't hesitate to go to another broker. If the broker says, "Oh, don't worry about that, you don't pay anything," go to another broker.

Only consider buying such a product if you can easily explain how it works to a friend -- after reaching conviction based on understanding the benefits and pitfalls described in the contract and other disclosures.

So that's the "free advice" route. Don't forget that the broker is not working for free -- he or she gets paid when you purchase the product.

If the fee is external, it is visible. If it's internal, it is not visible. In either case, the broker gets paid; he or she is not working pro bono.

Let's go further. It is always important to understand the cost of "advice" before purchasing a product or service. Cerulli, an international research and consulting firm, noted in its recent U.S. Advisor Edition that a certain type of person ("self-directed") has "little trust in financial providers" and is "not willing to pay for financial advice." Meryl and her husband seem to fall into this category. That's why they need to do their own homework. And, if they don't reach a level of conviction that the product achieves their goals, good for them. That's definitely a wise decision, since every investor has options.

The most important takeaway is to look at retirement as a transition that is unlike any other. The paycheck stops, but expenses continue, and the sources of cash to pay those expenses need to be understood. Some will come from Social Security and pensions; some will come from savings or investments.

Financial management of a household involves knowing your numbers for today and factoring in the loss of purchasing power due to inflation and taxes in the decades ahead.

A different set of investment rules govern after your retirement, all built around managing cash flow. Someone has to do that analysis for this couple before they even begin to think about what investments to buy. They can also do that themselves, of course, without needing to pay for the service. But will they? We'll have to wait and see.

If you have a situation you'd like me to discuss anonymously in this column, send me an email (readers@juliejason.com). While not all emails can be chosen for discussion, all of them are read and considered.

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