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After the death of a spouse, survivors often have to pay more taxes on lower income – what accountants and financial planners know as the “widow’s penalty”, because women typically outlive their husbands.
Barbara O’Neill, a certified financial planner and teacher in Ocala, Florida, says couples who know what’s going to happen can often take steps to minimize the impact of the penalty, but many think too far ahead. I don’t think so.
“A lot of people underestimate how much of an impact this will have economically,” says O’Neill.
There will be a decline in income but there will be no reduction in expenditure.
The death of a spouse often results in a sharp decline in income. Wages or salaries are typically lost if the deceased spouse was still working, and many people do not have enough life insurance to compensate for that loss.
If a couple is retired and receiving Social Security, the benefit amount may be reduced by one-third to one-half. Of the two checks the couple receives, the larger one goes to the survivor, and the smaller one goes to the beneficiary. If the deceased spouse received a pension or annuity payment, the survivor may receive a reduced amount or nothing at all, depending on which payment option the couple chose.
O’Neill, author of “Flipping a Switch: Your Guide to Happiness and Financial Security in Later Life,” says the drop in income can be offset by lower expenses, such as a reduction in grocery bills by one or two instead of one. Auto insurance for vehicle. But some expenses may increase. For example, the survivor may seek help to perform some tasks previously handled by the deceased. Or they may want to subscribe to a medical alert service now that they’re living alone, she says.
And then there are the tax bills.
Taxes and Medicare premiums may change after death
A surviving spouse may use favorable “married filing jointly” status in the year of their partner’s death, unless the survivor remarries before the year ends. After that, those left without dependent children are generally forced to use the less favorable “single” filing status.
The standard deduction for a married couple — $27,700 in 2023 — is double that for a single person. Additionally, taxpayers who are married and filing jointly can have taxable income up to $89,450 and remain in the 12% federal tax bracket. This bracket ends at $44,725 for single filers. The next tax bracket is 22%.
Survivors who receive Social Security may find that more of their benefits are taxed. Up to 85% of Social Security benefits are taxable if “combined income” – adjusted gross income, plus nontaxable interest, plus half of Social Security benefits – is more than $44,000 for a couple. For an individual, the limit is $34,000.
Survivors on Medicare may see their premiums increase, due to a surcharge known as the income-related monthly adjustment amount, or IRMAA. The surcharge is based on the tax returns of the previous two years. So couples earning more than $194,000 on their 2021 tax returns face a surcharge in 2023 that ranges from $65.90 to $395.60 per month. The surcharge came into effect when the income of single people exceeded $97,000.
Planning can help reduce fines
Financial planners say couples can help reduce the survivorship penalty by adding tax-free sources of income. Life insurance — which can provide tax-free income to survivors — is an option, but buying a large enough policy may not be economical for older people, O’Neill says. Another possibility is to keep at least some of the money in tax-free accounts, such as Roth IRAs and health savings accounts, so that survivors can better manage their tax bills.
Marianela Collado says that if most of a couple’s savings are in traditional retirement accounts, such as regular IRAs and 401(k), couples may want to consider converting at least some of the funds to a Roth IRA while they’re still eligible. Married enjoying joint filing rates. , chief executive of Tobias Financial Advisors in Plantation, Florida.
Many people shy away from paying the income taxes required for a conversion, not realizing that the tax situation may be worse for the survivor, says Collado, a member of the Personal Financial Planning Executive Committee of the American Institute of Certified Public Accountants. .
The conversion will not only increase the pool of tax-free money that the survivor can access, but will also reduce the future minimum withdrawal required that the survivor may face. Required minimum withdrawals for traditional IRAs, 401(k)s and other non-Roth retirement plans generally must begin at age 73.
Collado says a series of partial conversions over several years could spread the tax bill. However, consider getting tax advice before proceeding, as the conversion could push you into a higher tax bracket and affect other aspects of your finances, including Medicare premiums or Affordable Care Act subsidies.
This article was written by NerdWallet and originally published by the Associated Press.