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August 26, 2019 – 5 Pitfalls Widows Should Be Aware Of: What the Widows’ Penalty is, and What That Could Mean for You

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Written by Taylor Financial Group, LLC

Although it’s certainly more exciting to plan for the happy events in life, like weddings and children, it’s an unfortunate reality that couples cannot stay together forever. The gap in life expectancies between women and men (81 years versus 76 years) along with the gap in average marrying age (women most commonly marry at 27, while men most commonly marry at 29), means an unfortunate number of wives will outlive their husbands. And it might be more than you think – according to the 2010 US Census, there are 11 million widows in America, and about 700,000 women become widowed each year. In fact, roughly 34 percent of women 65 and older were widows in 2016. As the majority of men make more money than women, and the majority of husbands handle their family’s finances, an ill-timed death can bring about unexpected financial consequences. So even though it might be morbid to consider, it’s necessary that you plan for the unexpected, and be aware of what pitfalls might be laying in wait — planning best done while both you and your spouse are still living. More specifically, beware the widows’ penalty.

As you know, the tax brackets for a Single filer versus someone Married Filing Joint are vastly different. For example, a single person with an income of $250,000 would land in the 35% tax bracket, whereas a married filing joint couple with that same income would be taxed at a top bracket of 24%. It’s logical for the brackets to be done this way- it’s easier for two people’s combined salary to be higher than one person’s salary.

However, the plan fails once a couple retires. At that point, they switch from having an active income (coming from a salary) to a more passive one, where the money received comes from sources like their IRAs, Social Security payments, or pensions. And, as mentioned above, it is inevitable that you or your spouse (most likely the husband) will pass away before the other. Although in the year of your spouse’s death, you are considered married for tax reasons and can thus file as married filing joint, after that, you are on your own. This extra passive income will lead to your overall income drastically increasing, and likely pushing you into a higher tax bracket, meaning that you may end up paying significantly more in taxes and end up with less money than you are expecting. This is known as the widows’ tax or widows’ penalty, and often isn’t planned for, but can be crippling. Here are five pitfalls to watch out for when moving from a joint to a single filer, and tips on how to prepare for them.

  1. Filing your tax return won’t be the same 

Assuming the living spouse (like the vast majority of people) takes the standard deduction as opposed to itemizing, the available standard deduction amount will fall- a married couple is entitled to a standard deduction amount of $24,400, but as a single filer, the living spouse will only be able to claim a deduction of $12,200. Although dropping from a Married Filing Joint $24,400 standard deduction to a Single $12,200 standard deduction is significant, remember that the living spouse can claim an additional standard deduction amount if she is over 65. People over 65 can add $1,650 (if Single) or $1,300 (if Married Filing Joint) to their standard deduction amounts.

  1. Social Security can be a blessing, but watch out for the tax liability!

For Social Security, widows who are age 66 or above can claim the full survivor benefit. In addition, if both you and your spouse were receiving Social Security, the surviving spouse can choose between receiving her benefit, or the benefit of her deceased spouse. So, if the deceased spouse was receiving $25,000, while the surviving spouse was only receiving $15,000, the surviving spouse could opt to receive $25,000. However, this also leads to a greater tax liability. For those married filing jointly, 50% of their Social Security income is taxable if their overall income ranges from $32,000 to $44,000. If you and your spouse’s income goes over the upper limit of $44,000, though, this number jumps and an insane 85% of their Social Security amount becomes taxable. However, for single filers, the income ranges that correspond to the taxation levels are (obviously) lowered. For Singles with an income ranging from $25,000 to $34,000, 50% of Social Security income is taxable. But watch out- if the living spouse’s income breaks $34,000, 85% of Social Security becomes taxable, not a hard limit to break. It’s easy to see how the death of a spouse could lead to a drastic increase in taxable income from Social Security alone.

  1. Don’t forget about Medicare and IRMAA charges!

And the problem of the widows’ penalty isn’t limited to income taxes- Medicare surcharges can also target widows. More specifically, surcharges from the Income-Related Monthly Adjustment Amount (or IRMAA), can trip up widows. IRMAA is a higher premium charged by Medicare Part B and Medicare Part D to individuals with incomes that exceed $170,000 for a joint filer or $85,000 for a single filer. An individual’s Modified Adjusted Gross Income (MAGI) is used to determine the amount paid. So, while the married couple might have easily stayed below the $170,000 level, the additional income the widow receives from her late husband’s Social Security, IRA, or other account, could push her above the $85,000 threshold for single filers.

And, if the living spouse goes above this threshold by even one dollar, she is now in the next IRMAA tier and thus subject to an additional $54.10 per month for Medicare Part B, meaning her combined premium and surcharge is $189.60 per month. And, the IRMAA surcharge increases as income rises, to a combined premium and surcharge of $460.50 for Medicare Part B for individuals with a MAGI of $500,000 or more, so be aware of where your income falls in the bracket per the chart below. Although IRMAA surcharges effect less than 5% of the population, and widows are given a one-time appeal for an IRMAA surcharge, it’s still something to be aware of when going from a joint to a single filer, especially as the monthly adjustments can add up in the long run. And, there is also a Medicare Part D surcharge based on income levels, as well.

2019 Medicare Part B Total Premiums

File Individual Tax Return File Joint Tax Return Monthly Adjustment You Pay Each Month
0 to $85,000 $0 to $170,000 $0 $135.50
$85,001 to $107,000 $170,001 to $214,000 $54.10 $189.60
$107,001 to $133,500 $214,001 to $267,000 $135.40 $270.90
$133,501 to $160,000 $267,001 to $320,000 $216.70 $352.20
$160,001 to $500,000 $320,001 to $750,000 $297.90 $433.40
Above $500,000 Above $750,000 $325.00 $460.50
  1. Retirement planning is never easy- IRAs can pose some big problems

Widows under the age of 70.5 can transfer the money in her husband’s IRA to her own, and then allow it to continue growing tax free. But, assuming she has a Traditional IRA, if she is above the age of 70.5, she is forced to take Required Minimum Distributions, or RMDs, from both her and her deceased husband’s retirement accounts, whether she wants to or not. And this can increase her taxable income drastically. As RMD distribution percentages only rise with age, this tax liability will also increase over time. For example, if both you and your spouse each had a $2.0 million IRA and were each age 85, the RMD for each would be $135,135. When one spouse dies, the living spouse must take RMD’s from both IRAs based on the living spouse’s life expectancy, which would total $270,270, however the living spouse will be filing Single, which would increase the tax bracket from 24% to 35% (based on this income alone).

Some of this liability can be offset by converting a Traditional IRA to a Roth IRA. Roth IRAs help avoid the tax problems that come from having to pay RMDs, but a Roth Conversion might also result in an increase in current taxable income. And, once you reach the age of 70.5, the RMDs will begin, so this conversion should be done after you retire, but before you reach the age of 70.5, at which point it might not be worth the headache of a conversion. These plans are best made before your spouse passes away, to ease the tax burden incurred as well as your plans for retirement.

  1. Watch out for lump sums!

The problem of the widows’ penalty is further compounded if one spouse had some type of pension or other retirement plan paying a lump sum. Typically there are options for either a lump sum payment or monthly payouts. When deciding which one to choose, widows should consider their immediate needs, but also how this would affect their tax situation, especially if the payout is sizable. For larger amounts, a lump sum payment might bring the widow into an even higher tax bracket, meaning she would incur even steeper penalties, whereas a monthly payout could mean that she is kept in a lower bracket, which could save her significant amounts of money over time. However, as she is able to file as married filing jointly in the year of her husband’s death, an immediate lump sum might allow her to keep more of the payment than if she chose monthly payments, and was forced to be taxed as a single filer if the payments were spread over one year.

Overall, the widows’ penalty is an often unexpected and unwelcome surprise to women who haven’t had to deal with the disadvantages of being a single filer in many years. And while the differences in brackets for single and joint filers makes sense for younger earners, it’s rarely considered that, at some point, many people will unfortunately return to life as a single filer. To be more prepared for that day, consider discussing these issues and how taxes (and finances) will be managed in the event of your or your spouse’s death. Finally, please feel free to contact the Taylor Financial Group team to ensure that your financial plan is customized and tax sensitive!

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Securities offered through Cetera Advisor Networks LLC, Member FINRA/SIPC. Investment advisory services offered through CWM, LLC, an SEC Registered Investment Advisor. Cetera Advisor Networks LLC is under separate ownership from any other named entity.

This article is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.

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