It’s one of the most obscure taxes in the IRS code, but it can be one of the most devastating at a time when you can least afford it. It’s called the Widow’s Penalty Tax—a stealth tax you never see coming—that can cause a widow or widower to struggle financially.
When one spouse dies, the surviving spouse is now responsible for all the bills and has to maintain the household with less money. The household begins receiving only one Social Security check instead of two. If the deceased spouse was receiving a pension, it may disappear or change to a reduced amount.
On top of that, the surviving spouse is pushed into a higher tax bracket. When both spouses are alive, the couple’s tax return filing status is married filing jointly. But after one spouse passes away, the surviving spouse’s filing status changes to single. The married filing jointly status is the most beneficial while single filing status is unfavorable.
Bob Carlson, editor of Retirement Watch, says taxpayers who are married filing jointly stay in the 12% tax bracket until their taxable income exceeds $80,250 in 2020. But a single taxpayer stays in the 12% bracket only until taxable income exceeds $40,125. The 22% tax bracket applies to a married couple filing jointly until taxable income exceeds $171,050 but for a single taxpayer the ceiling is taxable income of $85,525.
A surviving spouse can file their tax return as married filing jointly for the year their spouse died. After that, they have to switch to single filing status.
Then, there’s the possibility that the surviving spouse will have to pay more for their Medicare health coverage. Higher-income Medicare beneficiaries have to pay a surtax called the Income-Related Monthly Adjusted Amount (IRMAA). If the surviving spouse retains most of the income that was coming in before the death of their spouse, they may end up paying as much or more of a Medicare premium surtax than the couple paid jointly.
And let’s not forget the tax on Social Security. Social Security benefits are included in gross income at a faster rate for a single taxpayer than for a married couple filing jointly.
How big an impact can the Widow’s Penalty Tax have? Research shows that in 75% of married couples, one spouse will outlive the other by at least five years. In about half of couples, one spouse will outlive the other by at least 10 years. Couples need to plan for the Widow’s Penalty just like they plan for retirement. Bob Carlson has these suggestions.
- You might decide to spend less in the preceding years to ensure more money is available for the solo years. Some people will buy permanent life insurance to provide a lump sum of tax-free cash to the surviving spouse.
- Another strategy is to increase future tax-free income. The widow’s penalty tax and the other Stealth Taxes of the solo years are good reasons to consider converting a traditional IRA to a Roth IRA now. Pay the taxes now at the lower married filing jointly rate to provide tax-free income in the future when the surviving spouse is likely to be in a higher income tax bracket as a single taxpayer.
- Remember that if a lot of money is in a traditional IRA or 401(k), the surviving spouse will have to take required minimum distributions, and the percentage of the nest egg that must be distributed increases each year. Having a traditional IRA or 401(k) could force a lot of money to be distributed when the surviving spouse is in a higher tax bracket.
There are things you can do to decrease the effect of the Widow’s Penalty Tax, but you have to do something. So, start to plan now instead of leaving the surviving spouse to deal with it after it’s too late.