Early in a relationship with a widowed client, I received a confused phone call from her. She had received a notice saying that her Medicare premium would be significantly increasing the following year, and she didn’t understand why. Now that her husband was deceased, she was receiving less in social security and taking fewer withdrawals from her retirement accounts. Her total income had gone down, so why would she have to pay more in Medicare premiums? She didn’t know it, but she was a victim of something called the “widow’s penalty.”
Less Income, More Taxes
Simply put, the widow’s penalty is when a surviving spouse ends up paying more taxes on less income after the death of their spouse. This happens when a widow or widower starts filing as a single filer in the year after their spouse’s death. And while it’s commonly referred to as the widow’s penalty, this tax problem impacts surviving spouses of all genders.
When the first spouse dies, the surviving spouse typically sees a reduction in income. While the surviving spouse will continue to receive the greater of the two social security benefits, they will no longer receive the lower benefit. Additionally, they will lose any other income tied only to the deceased spouse, such as employment income, single life annuity payments, or pensions with reduced or no survivor benefits. Depending on how much income was tied to the deceased spouse, the surviving spouse’s income may be drastically reduced.
At the same time the surviving spouse starts receiving less income, they find themselves subject to higher taxes. With some exceptions for individuals that claim qualified dependents, the surviving spouse is required to start filing taxes as single instead of as married filing jointly in the year following their spouse’s death. In 2023, that means they will hit the 22% bracket at only $41,775 in income. Married filers do not reach the 22% bracket until they have more than $83,550 in income. So even if their income stays the same, widowed filers will be paying higher taxes on the same income.
Tax brackets are not the only place surviving spouses are penalized. Like the client in my story above, many surviving spouses see their Medicare premiums increase even though their income has decreased because of the way the income-related monthly adjusted amount (IRMAA) is calculated. Specifically, single filers with a modified adjusted gross income of more than $91,000 are required to pay a surcharge on their Medicare premiums; whereas there is no surcharge until a couple who is married filing jointly reaches $182,000 of income. This means that a couple could have an income of $150,000 and not be subjected to the Medicare IRMAA surcharge, but if the surviving spouse has an income of $100,000, their premium will increase by almost $1,000 per year.
After a Spouse Dies
Short of remarrying, there is no way to avoid the widow’s penalty. However, if your spouse has recently passed away, there may be some steps you can take to minimize your total tax liability.
For most widows, the year their spouse dies will be the last year they will be allowed to use the higher married filing jointly tax brackets. In some cases, it can make sense to strategically realize income during the year of death to minimize the surviving spouse’s lifetime tax bill. One way a surviving spouse might do this is by converting savings from a Traditional IRA to a Roth IRA while they are still subject to the married filing jointly rates.
Another client of mine found herself widowed in early 2020 at the start of the Covid-19 pandemic. Thanks to some candid conversations, we were able to take advantage of her last year of married filing jointly by doing a Roth conversion. As a married filer, she was at the low end of the 24% bracket. Once she was filing as a single filer, she would be in the 32% bracket. We decided to do a Roth conversion in 2020 to transfer $150,000 from her Traditional IRA to a Roth IRA at 24% because all future distributions would be taxed at 32%. While she had a larger tax bill that year, she was ultimately paying less in taxes on that distribution than she would be if she withdrew it after 2020 when she was a single filer. The timely transfer saved her $12,000 in taxes on that single distribution. It also decreased her future required minimum distributions, which will save her even more in future years.
Strategically realizing more income in the year of death will increase your tax bill in that year but can help reduce the taxes you pay over your lifetime. If you find yourself in this situation, talk with your advisor to see if a strategy like this makes sense for your situation.
You may be confident of your financial situation right now, but the fact is that, barring a divorce, the widow’s penalty will be a reality for one member of every married couple eventually. By planning for the widow’s penalty before it becomes an issue, you can take steps to reduce its impact.
Younger couples can consider strategies like saving more in tax free investment vehicles or using life insurance to offset future tax bills. Maximizing the amount of assets you have in tax-free investment accounts like a Roth IRA will decrease your taxable income in retirement and will in turn make you less susceptible to the penalty. Another strategy is to use life insurance to provide additional financial resources for the surviving spouse. While a life insurance policy will not decrease your future tax bills, it will certainly help you pay them.
Older couples might not have these options available to them, but knowing ahead of time that the widow’s penalty impacts the success of your plan can give you time to decide if you want to reduce your spending now so the surviving spouse will not have to make drastic lifestyle changes.
The most important step you can take is to discuss the widow’s penalty with your advisor. They can model the impact of one spouse’s death on your financial plan and help you determine what strategies are right for you when dealing with these potential tax consequences.