The death of a spouse is traumatic. Rather than take time to grieve, the surviving spouse has to make decisions and handle a daunting number of legal procedures and forms when all they really want to do is take the time to process their loss.
Adding to the unpleasantness, they often quickly discover the financial implications. In what’s known as the widow’s penalty, losing a spouse can frequently pose a triple threat to the survivor’s financial situation.
Social Security payments
The most obvious, for retired couples who collect Social Security, is that the survivor now only collects one check per month, whereas the couple had been collecting two. The surviving spouse will get the higher of the couple’s individual benefits, but it’s still likely to be a significant loss of income.
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Similarly, if one person has a pension and they pass away, that income will either stop entirely or will be reduced as the pension converts to a survivor’s benefit pension.
Medicare premiums
At certain income levels, the death of a spouse can even impact the cost of Medicare. Medicare Parts B and D premiums are calculated based on modified adjusted gross income. These premiums could cost more even if the surviving spouse’s income drops by nearly half.
Taxes
Far less obvious, but arguably more damaging, is that the widow or widower will no longer be able to file a joint tax return.
There’s a grace period of one year after their spouse’s death, or two years if the couple has qualifying children, during which the survivor can continue filing jointly. After that period ends, they must file a single tax return.
That means their tax brackets can shift, often considerably.
For example, in tax year 2025, a retired married couple filing jointly with an annual income of $96,000 will be in the 12% tax bracket. If one spouse dies and the household income drops to $24,000, the single-filer survivor will be in the 22% bracket.
As icing on the cake, the standard deduction for taxpayers who switch from joint to single filing is cut in half.
Clearly, the widow’s penalty adds a great deal of financial misery on top of an already painful life event. However, there are ways to lessen its impact.
Frequently, when I take on married couples as clients, I notice aspects of their financial plans that seem solid until you factor in the widow’s penalty, at which point the plan becomes a tax trap that will spring when one spouse passes away.
Too many taxable withdrawals can cost you money
Retirement income can be divided into two main types: taxable and non-taxable.
Taxable income includes streams such as required minimum distributions from a 401(k) or IRA, while non-taxable income streams come from vehicles such as Roth 401(k)s and IRAs, indexed universal life policy death benefits and, for qualified medical expenses, withdrawals from health savings accounts (HSAs).
By structuring retirement income to reduce the reliance on taxable sources, the widow’s penalty can be, at least partially, circumvented.
For example, by converting traditional retirement accounts to their Roth equivalents, it’s sometimes possible to drop the survivor’s income low enough to avoid some of the penalties, such as increased tax brackets.
Needless taxation
Often, when one spouse dies, the survivor decides to downsize and sells the home they shared. Many know that when an heir inherits a home, it steps up in basis.
For capital gains purposes, the home is considered to have been purchased at its value at the time it was inherited rather than when it was actually bought.
A surprising number of clients come to me unaware that when a spouse dies, a step-up in basis also applies. In community property states, the home is eligible for a 100% step-up in basis; in non-community property, the step-up is 50%.
Either way, that represents a significant capital gains savings potential.
Structuring Social Security
If one spouse was earning significantly more than the other, and that spouse delays taking Social Security benefits until age 70, their widow can keep the higher Social Security benefit when they die, and that benefit will be boosted by 8% for each year they delay between ages 67 and 70.
With careful planning, couples can enter retirement secure in the knowledge that, whichever spouse passes away first, the survivor’s exposure to the widow’s penalty will be minimized.
This planning is complicated, with many nuances to be aware of. It’s important to work with a trusted financial adviser who can help guide you to the right plan for you and your unique situation.
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