Reduce Your ‘Widow’s Penalty’ by Planning Ahead

After a spouse dies, the survivor often ends up paying higher taxes on less income — something known by accountants and financial planners as the “widow’s penalty,” because women typically outlive their husbands.

Couples who know what’s coming often can take steps to soften the penalty’s effect, but too many don’t think far enough ahead, says Barbara O’Neill, a certified financial planner and educator in Ocala, Florida.

“A lot of people just underestimate what the impact will be financially,” O’Neil says.

A spouse’s death often leads to a substantial drop in income. Wages or salary typically end if the deceased spouse was still working, and many people don’t have enough life insurance to replace that loss.

If a couple is retired and receiving Social Security, the benefit amount can drop by one third to one half. The survivor gets the larger of the two checks the couple received, and the smaller benefit goes away. If the deceased spouse received pension or annuity payments, the survivor may get a reduced amount or nothing at all, depending on what payout option the couple chose.

The income decline may be offset by lower expenses, such as reduced bills for groceries or auto insurance for one vehicle instead of two, says O’Neill, author of “Flipping a Switch: Your Guide to Happiness and Financial Security in Later Life.” But some expenses could go up. The survivor may hire help to perform some of the chores the deceased previously handled, for example. 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.

A surviving spouse can use the favorable “married filing jointly” status in the year their partner dies, as long as the survivor doesn’t remarry before the year ends. After that, survivors without dependent children are typically forced to use the less favorable “single” filing status.

The standard deduction for a married couple — $27,700 in 2023 — is twice that of a single person. Plus, taxpayers who are married filing jointly can have taxable income up to $89,450 and remain in the 12% federal tax bracket. That bracket ends at $44,725 for single filers. The next tax bracket is 22%.

Survivors receiving Social Security can find that more of their benefit gets 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 — exceeds $44,000 for a couple. For a single person, the limit is $34,000.

Survivors on Medicare might see their premiums rise, thanks to a surcharge known as the income-related monthly adjustment amount, or IRMAA. The surcharge is based on the tax return from two years prior. So couples with incomes over $194,000 on their 2021 tax returns faced a surcharge in 2023 that ranged from $65.90 to $395.60 per month. The surcharges kicked in for singles when their income exceeded $97,000.

Couples can help reduce the survivor’s penalty by adding tax-free sources of income, financial planners say. Life insurance — which can provide tax-free proceeds to the survivor — is one option, but buying a sufficiently large policy may not be affordable for older people, O’Neill notes. Another possibility is having at least some money in tax-free accounts, such as Roth IRAs and health savings accounts, so survivors can better manage their tax bills.

If most of the couple’s savings is in traditional retirement accounts, such as regular IRAs and 401(k)s, couples could consider converting at least some of the funds to a Roth IRA while they still enjoy favorable married filing jointly rates, says Marianela Collado, chief executive of Tobias Financial Advisors in Plantation, Florida.

Many people balk at paying the income taxes conversions require, not realizing the tax situation could be worse for the survivor, says Collado, a member of the American Institute of Certified Public Accountants’ personal financial planning executive committee.

Conversions not only would increase the pool of tax-free money the survivor could draw on, but also reduce any future required minimum withdrawals the survivor might otherwise face. Required minimum withdrawals typically must start at age 73 for traditional IRAs, 401(k)s and other non-Roth retirement plans.

A series of partial conversions over several years could spread out the tax bill, Collado says. Consider getting tax advice before proceeding, however, since conversions could push you into a higher tax bracket and affect other aspects of your finances, including Medicare premiums or Affordable Care Act subsidies.