Losing a spouse is an incredibly stressful and traumatic event, and financial advisers often advise surviving spouses to take time before making major financial decisions. However, there is a phenomenon known as the widow’s or widower’s penalty that can result in a significantly higher tax bill if not addressed promptly.
The widow’s penalty occurs when a surviving spouse’s tax status changes from married filing jointly to single. While a widow or widower can file a joint tax return for the year of their spouse’s death, they are required to file as a single taxpayer thereafter unless they have dependent children. This change in filing status can lead to a higher tax bill, even if the surviving spouse’s income remains the same or decreases due to changes in Social Security and pension benefits.
One factor that can exacerbate the tax hit for surviving spouses is the requirement to take minimum distributions from an individual retirement account (IRA). This can result in higher tax rates on the same amount of income received while the spouse was alive. For example, a married couple filing jointly with up to $383,900 in taxable income qualifies for the 24 percent tax bracket in 2024. However, a single filer with the same taxable income would jump to the 35 percent tax bracket.
Ed Slott, founder of IRAhelp.com, highlights the discrepancy between the tax scenario in our country and real-life situations. The tax system assumes that a single person makes half of what a married couple makes, but this is not always the case. Slott suggests that surviving spouses take advantage of their joint filing status in the year of their spouse’s death to mitigate the widow’s penalty.
One effective strategy is to convert as much of the traditional IRA into a Roth IRA during this window. Although taxes must be paid on the conversion, the rate is generally lower than what would be paid as a single filer. The benefit of a Roth IRA is that withdrawals are tax-free as long as the individual is at least 59½ years old and has owned a Roth for at least five years. Additionally, there are no required minimum distributions from a Roth IRA.
It’s important to note that a large conversion could trigger a high-income surcharge on Medicare Part B and Part D premiums. However, this would be a one-time hit to Medicare premiums, and future withdrawals from a Roth IRA would not affect the surcharge. Slott emphasizes that this is a small sacrifice for the long-term benefits of tax-free withdrawals from a Roth IRA.
In conclusion, surviving spouses should be aware of the widow’s or widower’s penalty, which can result in a higher tax bill when their tax status changes to single. By taking advantage of the joint filing status in the year of their spouse’s death and converting traditional IRAs to Roth IRAs, surviving spouses can mitigate the impact of the widow’s penalty. This strategy can lead to lower taxes in the long run and provide greater financial stability during an already difficult time.
