Retirement income is a hot topic of conversation and is also a concern for many pre-retiree clients, and for good reason. How much money can I spend in retirement? Which accounts will that money come from? And so on.
However, most people don’t consider how taxes affect this equation, particularly lifetime taxes. Furthermore, most clients don’t consider how lifetime taxes affect the surviving partner, usually the woman.
When one spouse passes away, the surviving partner will likely pay taxes at a substantially higher tax rate and tax bracket, something that most couples don’t expect. As women live longer and couples accumulate more wealth, this issue becomes increasingly costly.
What is the challenge?
Many couples benefit from the “Married Filing Jointly” tax filing status, which offers favorable tax brackets (except at the highest level). However, after a spouse’s death, the survivor must file as “Single,” which uses tax rates that are roughly half the taxable income of the “Married Filing Joint” bracket. In addition, the change of filing status to Single cuts the standard deduction in half (from $29,200 to $14,600) and also reduces key income thresholds.
“By preparing for this necessary change in your clients’ lives, you could save clients important dollars on their lifetime taxes.”
Any of these changes alone is damaging, but taken together, these tax adjustments typically push the surviving spouse into a higher tax bracket or at least significantly higher in the current tax bracket. Consequently, the surviving partner ends up with about a 10% increase in the annual tax rate and higher Medicare premiums.
Are you helping clients plan for the “widow’s penalty?”
Read below for three ways to prepare your clients so they don’t get caught in this tax trap.
1. Understand the two biggest changes
There are two major changes that happen when a person’s spouse passes away. The first is losing the tax benefits that come with filing jointly with a spouse. This means that the spouse is left with less tax-free income.
Additionally, the tax brackets are much smaller. For example, if your client has $85,000 of total income and they are married filing jointly, then they are in the 12% tax bracket. But, if your client is filing Single with $85,000 of total income, then they will be in the 22% tax bracket.
This is a dramatic change, almost doubling the tax burden on the survivor very suddenly. In dollar terms, for taxpayers taking the standard deduction, this amounts to paying $6,232 in taxes when filing Jointly, increasing to $10,541 in taxes when filing Single.
We included the 2024 tax brackets below to help visualize the difference in the tax bracket structure for Single versus Married Filing Jointly.
| Table 1: 2024 Tax Rate Schedule |
| Taxable income ($) |
Base amount of tax ($) |
Plus |
Marginal tax rate |
Of the amount over ($) |
| Single |
| 0 to 11,600 |
|
+ |
10.0 |
|
| 11,601 to 47,150 |
1,160.00 |
+ |
12.0 |
11,600.00 |
| 47,151 to 100,525 |
5,426.00 |
+ |
22.0 |
47,150.00 |
| 100,526 to 191,950 |
17,186.50 |
+ |
24.0 |
100,525.00 |
| 191,951 to 243,725 |
39,110.50 |
+ |
32.0 |
191,950.00 |
| 243,726 to 609,350 |
55,678.50 |
+ |
35.0 |
243,725.00 |
| Over 609,350 |
183,647.25 |
+ |
37.0 |
609,350.00 |
| Married filing jointly and surviving spouses |
| 0 to 23,200 |
|
+ |
10.0 |
|
| 23,201 to 94,300 |
2,320.00 |
+ |
12.0 |
23,200.00 |
| 94,301 to 201,050 |
10,852.00 |
+ |
22.0 |
94,300.00 |
| 201,051 to 383,900 |
34,337.00 |
+ |
24.0 |
201,050.00 |
| 383,901 to 487,450 |
78,221.00 |
+ |
32.0 |
383,900.00 |
| 487,451 to 731,200 |
111,357.00 |
+ |
35.0 |
487,450.00 |
| Over 731,200 |
196,669.50 |
+ |
37.0 |
731,200.00 |
Source: Horsesmouth
Remember the widow penalty also affects IRMAA Medicare surcharges, often causing the widow to pay more in IRMAA surcharges as a single person than the couple did while both were alive. Consider income of $225,000 as a reference point, where the couple would pay $6,000 in IRMAA surcharges versus $7,380 for the surviving spouse.
Pro tip: This can be a big issue as not only will the surviving spouse possibly have slightly less income (at least in the first few years of widowhood), but they have to pay more in taxes, leaving them with less dollars when they need it most. The widow’s penalty takes a large chunk out of the client’s retirement income for this reason.
2. Take advantage of low tax rates while your client has them
So how do we plan for this? By using the married filing joint tax brackets while you can.
One spouse is likely to pass away first, so advisors should be prepared when that happens. The surviving spouse will generally retain about 90% of the income since they inherit the IRAs and can claim the higher Social Security benefits of the deceased spouse, giving up their typically lower amount.
Now, before one spouse dies, may be the best time to pay taxes on those tax-deferred vehicles like IRA accounts and 401(k)’s while your clients are still in the more generous married filing jointly tax brackets.
Additionally, if your clients are going to be drawing larger RMDs in the future on those large retirement account balances, now is the time to start reducing that potential liability!
You should consider distribution planning while the clients are in their 50s and 60s, and particularly before Social Security and RMDs begin. Distribution planning can look like a lot of things, but it encompasses asset location, strategic withdrawals from accounts, tax loss and capital gain harvesting and Roth conversions to maximize these types of opportunities and reduce liabilities.
For instance, we had a couple in their early 70s with a combined tax-deferred balance of about $2 million, falling in the 10% tax bracket. We advised them to do a $115,000 Roth conversion while staying within the 22% bracket. The deciding factor was our projection showing that, after the first spouse’s death, the survivor would likely move into the 32% bracket or higher, assuming current tax rates remain unchanged.
This is a main reason why most people will pay tax rates that are higher in retirement than immediately before retirement—there will be a sole survivor and she will be filing Single.
Pro tip: Additionally, keep in mind that current tax rates are historically low, and many experts anticipate increases due to the nation’s debt crisis and overspending. With the Tax Cuts and Jobs Act of 2017 set to expire at the end of 2025 (without changes from Congress), now is the ideal time to capitalize on this “tax sale.”
3. Leverage the last joint tax return
Filing a deceased person’s final income tax return is crucial from a tax management perspective, especially for the surviving spouse.
The year the spouse passed is the last opportunity to file a joint return, so you may want to accelerate income before the survivor begins filing Single in the following year. Review the deceased person’s assets for time-sensitive opportunities.
For instance, if they have deferred interest on a portfolio of I bonds, the final tax return is an ideal time to recognize that. Of course, also consider Roth conversions, capital gain harvesting and anything else that generates income and determine when you desire the timing of that income.
Pro tip: Consider tax rates if your client’s spouse passes away. If the tax rate in retirement is likely to be higher once factoring in Social Security and RMDs, engage in tax planning now. Most husbands don’t want their wives to face a significant tax bill after they’re gone and are typically inclined to act now. Always compare your client’s current tax rate to three potential future rates: when RMDs start, the Single filer rate, and the tax rate of heirs inheriting a large IRA.
By preparing for this necessary change in your clients’ lives, you could save clients important dollars on their lifetime taxes. More importantly, you will be there to protect the surviving partner from the devastating impact of the widow’s penalty, ensuring the survivor can continue to enjoy the retirement that she has long saved for.