Avoid Being Caught Off Guard by the Widow's Penalty

If one spouse dies, the surviving spouse might end up paying almost twice as much in taxes. Have you thought about this possibility?

The “widow’s penalty” happens when a person begins to file a single tax return instead of jointly. This change can cause the surviving spouse to have to pay nearly double in taxes. In the example below, Jill’s spouse, Bill, passed away prematurely.

Source: www.kiplinger.com

While Bill and Jill were together, they filed their taxes jointly and both received Social Security income. As they were both older than 73, they were required to take required minimum distributions (RMDs). Their combined income resulted in a tax bill of $11,053. When Bill passed away, Jill was required to continue the same RMD amount as she was the beneficiary and received all the investments. However, two major changes occurred.

Firstly, Jill’s Social Security income ceased. When one spouse passes away, their Social Security income stops, and the higher of the two remains.

Secondly, Jill’s tax status changed from married filing jointly to single. As a result of these changes, Jill’s total tax liability increased to $17,141.

Here's how it works from a technical perspective:

The standard deduction is halved, leaving the surviving spouse with less tax-free income.
The tax brackets become smaller.

For example, if you have $85,000 of taxable income and file jointly, you're in the 12% tax bracket.

If you're single with the same income, you're in the 22% tax bracket.

This is how the nearly doubling of taxes can occur.

Not only will the surviving spouse have less income, but they will also face higher tax payments.

How can we plan for this?

Take advantage of the married filing jointly tax brackets while you can. If one spouse is likely to pass away much sooner, be prepared for that eventuality. Consider that tax rates may be the lowest we’ll see because they are among historical lows. Most experts expect them to increase in the future. Now may be the best time to pay taxes on accounts such as your IRA and 401(k)! Roth conversion can help you maximize these types of opportunities.

Optimize when you take Social Security to ensure your spouse will be left with the highest benefit when you pass away.

If you are going to be taking larger RMDs in the future, now is the time to start reducing that potential liability, leaving your spouse with less taxable income in the future.

The tax code penalizes those who have saved and those who have had a spouse pass away early. Unfortunately, you can change only what you can control. We cannot control the tax code, but we can control how we plan for it.

Start planning now and make sure your loved ones can continue with the lifestyle they deserve!