Planning for the Widow’s Tax Penalty
Widowhood often brings financial challenges as the surviving spouse’s tax situation changes. Planning ahead may help alleviate some of the added tax burden.
If you’re a couple filing your taxes jointly, one of you will likely file as an individual someday down the road. The widow’s “tax penalty,” or “tax trap,” as some people call it, refers to the situation many surviving spouses face when having to pay more taxes in the years following their spouse’s passing. Here are some reasons why:
A widow’s filing status could change
The way tax brackets are structured now, we think they benefit those who are married versus those who are single. Widows often receive less income but will be pushed to higher tax brackets. In addition to higher tax rates, widows lose half the standard deduction as a single filer, increasing their tax bill as a result.1
For example, Dave and Jane are married and file their taxes jointly. They have around $90,000 in income, which includes $50,000 in required minimum distributions (RMDs) from their IRAs each year and $40,000 in pension benefits. Dave dies, but Jane is still required to take the $50,000 of RMDs and is now receiving $20,000 in survivor pension benefits. She receives $20,000 less per year but has now moved from the 12% tax bracket as a joint filer to the 22% bracket as an individual.2 In addition, her standard deduction has also decreased significantly now that she’s filing as a single taxpayer. Jane is saddled with a higher tax bill even though she’s receiving less income.
Taxes on Social Security may increase
Widows may also elect to claim their deceased spouse’s Social Security benefits if these benefits are higher than their own. Taxation of Social Security benefits is based on income brackets that are more favorable to joint filers versus single filers. Many times, electing to receive the higher benefit will push the taxation of those Social Security benefits from 50% being taxable to 85%.3
A widow’s Medicare premiums may rise
Widows also face the challenge of higher premiums charged for Medicare. The Medicare surcharge comes from the income-related monthly adjustments amount (IRMAA). IRMAA is a higher premium charged by Medicare Part B and Part D, based on an individual’s modified adjusted gross income. Medicare recipients in 2024 with incomes greater than $206,000 for joint filers (or $103,000 for singles) are subject to higher premiums. For wealthier individuals, widows feel the crunch even further, with more expensive premiums to pay.4
How to lessen the impact of the widow’s ”tax penalty”
We believe doing some planning while both spouses are alive is the best way to mitigate the impact of the above situations in later years. In our view, reducing the income a widow is required to take is key when planning for their future and managing taxes. First, consider accumulating a mix of both taxable and retirement assets in your younger years. This may reduce the impact of future required RMDs on IRAs for the surviving spouse. Withdrawing funds from a taxable account at capital gains rates may leave the widow with a much better tax situation than withdrawing it at ordinary income rates from a retirement account.5
Second, consider a Roth IRA conversion of some (or all) of your retirement assets. Even though paying taxes on the conversion may sting a bit in the near term, doing it while having the luxury of the joint filing tax brackets could leave the future widow with the option to withdraw funds from a Roth IRA on a tax-free basis versus within a traditional IRA as ordinary income.6 This will also reduce the RMDs that may become a tax burden in the future.
Many couples plan for the day that assets will be transferred to their children; why not plan for the day that one of you will no longer be around for the other? Being tax-efficient now could help improve the surviving spouse’s financial picture for years to come.
Please note that every individual’s situation is different, so it’s important to speak with your Corient Wealth Advisor and consult with a tax advisor to determine what the best steps are for your particular circumstances.
1 https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024
2 https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024
3 https://www.usatoday.com/story/money/taxes/2024/01/01/is-social-security-taxable/71803090007/
4 https://www.kiplinger.com/retirement/medicare/medicare-premiums-2024-irmaa-for-parts-b-and-d
5 https://www.forbes.com/advisor/retirement/rmd-basics-required-minimum-distributions/
6 https://www.investopedia.com/terms/i/iraconversion.asp
ABOUT THE AUTHOR
Jenny Chung
Jenny is an Associate Partner, Wealth Advisor in our Itasca, IL, office. She uses her background as a teacher to help individuals and families feel comfortable with their investments and planning. She also works in the firm’s Divorce Practice Group, which helps divorcing individuals navigate the process and works closely with them afterward to help them build a full life.
