Ready For Retirement
Ready For Retirement
How to Avoid the Widow’s Tax (Before It’s Too Late)
When one spouse passes away, the survivor often faces what is known as the “widow’s tax.” It is not an official IRS tax, but the impact of moving from married to single tax brackets. A couple earning $120,000 in the 12 percent bracket can see the surviving spouse pushed into the 24 percent bracket with the same income. This tax bracket compression happens at the most vulnerable time.
Watch as James outlines three strategies that help protect a surviving spouse from this financial burden. Strategic Roth conversions can reduce future tax exposure by shifting assets from pre-tax to Roth while in lower brackets. Maximizing Social Security benefits creates a stronger income floor through survivorship benefits. Understanding and applying the IRS life expectancy tables for Required Minimum Distributions ensures more efficient withdrawals.
These approaches require careful timing and planning, but they can ease the long-term financial impact on a surviving spouse. Proactive strategies today can secure greater financial stability for tomorrow.
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The strategies, case studies, and examples discussed may not be suitable for everyone. They are hypothetical and for illustrative and educational purposes only. They do not reflect actual client results and are not guarantees of future performance. All investments involve risk, including the potential loss of principal.
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Most couples plan their finances together, but very few plan for what happens when one spouse passes away and the result? Well, it's a surprise tax bill that can crush the surviving spouse if you don't take steps to proactively alleviate this on the front end. So today I'm going to show you three things you can do right now to take steps to protect your loved one long after you have passed. Practically speaking, what we're talking about today is the widow's tax. Have passed. Practically speaking, what we're talking about today is the widow's tax. Instead of telling you what the widow's tax is, let me show you a quick example to show you how devastating it can potentially be to a surviving spouse. Here you can see on my screen is tax brackets for the 2025 tax year. But before we dive into these, let's assume that you're married and let's assume that you and your spouse have $10,000 per month of income, so $120,000 per year If you're under 65, meaning if you don't have an increased standard deduction, your standard deduction for married filing jointly is $30,000 per year and for single is $15,000 per year.
Speaker 0:So let's see how things would change if one of you were to unexpectedly pass away. So let's start with $120,000. If you have $120,000 of income, you can take a $30,000 standard deduction if both of you are still living. So of that $120,000, your taxable income is now down to $90,000. If we compare that to these tax brackets here, you see that the first $23,850 of that $90,000 of taxable income is subject to a 10% tax rate and the remainder is subject to a 12% federal income tax bracket. So you're in the 12% marginal tax bracket. So keep that in mind. Now let's look at what would happen if one of you were to pass away and if you were to maintain that same level of income. So $10,000 per month, $120,000 per year. If you're single, you don't get to deduct $30,000 any longer. You can only deduct $15,000 as your standard deduction. So now your taxable income is $105,000. So not just is your taxable income higher, but the tax brackets that you're comparing that to, or that you're filling up, have lower thresholds.
Speaker 0:Before you jump into higher brackets, let's take a look at that here. You can see that the first 11,925 is subject to 10%. So you blow right through that. Then the next amounts up to 48,475, right, 12%. You've blown through that because, keep in mind, we need to get to a full 105,000. Here you go all the way through the 22% tax bracket and you're into the 24% marginal tax bracket with the same exact income that you previously had when you were married. Now the reality is typically, when one spouse passes away, you're not spending the exact same amount, but I wanted to illustrate this to you so you can see what the challenge is is the marginal tax bracket in this example jumps from 12% to 24% for the surviving spouse. So what are some things that you can do today to protect your spouse against when this is going to happen, because chances are very good you're not both going to pass away at the same time.
Speaker 0:So let's jump right into this, and as we do this, we're going to take a look at sample clients. Luke and Mary Information in here just to illustrate what we're going to be talking about. They have about $2.7 million in investments today. You can see how that's broken down, and what I'm going to illustrate here for you is the most important thing, or one of the most effective things you can do if you're retired is going to be a Roth conversion strategy, but not in the typical way you might think. So, generally speaking, when we're considering a Roth conversion strategy, what we're looking at is at a high level.
Speaker 0:What do we expect your taxable income to be? Your taxable income today, based upon income sources you have today, your taxable income a few years from today and, most importantly, your taxable income beyond required minimum distribution ages, in other words, the age at which you're going to be required to start taking distributions from your IRA. What are you expected to be in terms of a tax bracket at that point? So that's what you can see right here is when we take your taxable income and then overlay what tax brackets are, we get a general sense of in what years what tax brackets you might be in. So this purple bar, what you can see I'll zoom in here this purple bar is showing what your taxable income, or what the sample client's taxable income is going to be. And then we're overlaying various tax brackets on top of that and what you can see is this blue bar. Here that's a 10% tax bracket, here's a 12% tax bracket, 22%, 24%, 32% and what we want to do is find those years where you're expected or where they're expected to be in lower income tax brackets, and what we're comparing that to is where they expected to be in the future, and what we can see is they're expected to be in the 22% bracket once required distributions kick in, and then the very, very end of their lifetime maybe just barely dipping their toes into the 24% tax bracket. So that's as things stand today.
Speaker 0:But what I mentioned is that's only part of the equation. The other thing we want to do is understand how does this change, not if, but when one spouse predeceases the other. So if I go back to this, I started with life expectancies of 95 for Luke and 92 for Mary, just as a starting point. Obviously, that's nothing that can be guaranteed, but something that we want to at least use as a starting point. But what happens if Luke passes away one year after retirement? Now, nobody believes this is going to happen to them, but it does happen, and so how do we make sure that we're prepared to understand? What would the consequences of that be in this case? So let's change Luke's life expectancy here to 68.
Speaker 0:Well, if we go back to the tax tab, let's take a look at this. This is just a projection of what tax bracket would Luke and Miriam be in today. So, assuming they're both living, here's the marginal tax bracket that we would expect them to be in. You can see, maybe it ends up somewhere in the 24% bracket. But if we switched over this cold proposed plan obviously we're not proposing that Luke passes but in that new comparison plan, what would the tax rate be for Mary in this case? Well, what we can see is previously, when they're in the 22 to 24% tax bracket. Now Mary is in a 32% tax bracket, up into the 35% tax bracket in many years. So the reason for this is exactly what I showed at the beginning of the survivor's tax, the widow's tax, even for the same levels of income. And, by the way, as part of this analysis, I'm factoring in a 15% reduction in overall expenses for Mary upon Luke's passing. And even with that, she's projected to be in much higher tax brackets. And it's not because of her spending, it's because of projected required distributions that she's going to have to take, regardless of how much she actually wants to spend. So what can they do to alleviate this?
Speaker 0:Let's go back to the tax strategies. Here again is where we left off last time, showing the taxable income and what tax brackets do they fill up. But how does this change if Luke passes away? Well, under that plan or that scenario, what you can see here is what we just looked at Mary's projected to be in a far higher tax bracket, not because of any extra income she's taken in, but because of compressed tax brackets. So when you can start to illustrate this, when you can start to see this, that's where we can start to understand how might various conversion strategies what if you fill up the 12% tax bracket? Filling up essentially meaning converting.
Speaker 0:How do you convert assets from Luke and Mary's traditional IRAs into Roth IRAs in a year in which they're under the 12% marginal tax bracket? Well, you can see that doing this is going to be beneficial to the tax adjusted ending wealth that they might have, but it's not making that big of a difference. Mary is still, even in this scenario where they're doing the conversion up to the 12% tax bracket. She's still expected to be in a very, very high tax bracket in the future. There's not been enough of a movement to get pre-tax assets into Roth assets for that to make too dramatic of an impact. So you can start modeling out. How would this change? What happens if you do the 22% bracket? Convert all assets from IRAs to Roth IRAs only to the extent that you're filling up the 22% tax bracket. And once you start to do that, not only is Mary in this instance saving a lot more money, so a lot more protection for Mary, but what you can see is, if this was the projection, this was her taxable income prior to conversions. If I get rid of this and now just show, here's her adjusted taxable income with the conversions, the impact that that had is she's no longer expected to cross into that much higher tax bracket. So the specific numbers for you, of course, will be much different. And, by the way, if you want to be able to model out your scenario with this tool, you can get access to this in the Retirement Planning Academy. Link is in the show notes below.
Speaker 0:But the point that I want to get across is, if all you're doing is modeling out Roth conversion strategies if you're married while the both of you are living, that's a great place to start. That's where you should start. That's base case. But as time passes and as you try to see, how do we not just optimize our tax strategy but also implement a tax strategy to protect a surviving spouse? You must also be taking into account how would this change if one spouse were to pre-decease the other? Those are the two ways that you should be looking at this. So that's number one.
Speaker 0:First way that you can help to protect your surviving spouse against the widow's tax is to implement the right kind of Roth conversion strategy, not just looking at what do you do when the two of you are living, but how would that change if one of you were to pre-decease the other, especially if that were to happen early in your retirement? The second thing that you can do to protect against the widow's tax is to maximize your social security benefit. Now, the way social security works is if one spouse pre-deceases the other, the surviving spouse has the option of either collecting their own Social Security benefit or they can collect the full amount of what the deceased spouse was collecting or would have been collecting, depending on the timing of when this happens. Now, this doesn't actually minimize the tax hit of required minimum distributions, like the Roth conversion strategy would, but what it's doing is it's maximizing the income. So if a much bigger chunk of income is now being paid in taxes when one spouse is surviving and the other is deceased, well then at least having a higher social security benefit is going to provide a stronger floor, a stronger base, more income for that surviving spouse. What you want to avoid is an instance where all of your income a big chunk of it is now being paid in extra taxes due to the widow tax and, by the way, the widow tax isn't an IRS name of a tax, it's just what it's called. When you say the compressed tax brackets for the surviving spouse in many cases are going to be a lot more challenging to deal with than they were when you're married jointly. So how do you deal with that? Well, you increase income in other places In retirement no-transcript. That's going to help protect the surviving spouse because it's a stronger, tax efficient income floor that could potentially offset some of the additional taxes owed on other assets. So that's the second thing that you can do. And then the third thing you can do is understand how different RMD tables come into play and how you can use them to your benefit.
Speaker 0:When we hear RMD required minimum distribution, we typically think one simple formula, or at least one formula. Maybe it's not simple. That's not the case, though. There are different life expectancy tables that the IRS allows you to use, depending upon the situation. You have the uniform lifetime table, you have the single life table and you have the joint and last, survivor table. So what's the difference and when should you use each? Well, the uniform lifetime table is going to be the one that's most common. That's the table where, if you say, here's my IRA balance and I'm at required minimum distribution age, how much do I need to start taking? This is the table that the IRS says if you're this age, here's what we expect your life expectancy to be and that's the number you use to compare your IRA balance and determine, or to calculate, how much do you owe in a required minimum distribution for that year. So that's the most common one, but there's two others. The second is the single life table.
Speaker 0:Now, typically, the single life table is being used if you inherit an IRA from someone that's a non-spouse. So you had an uncle that passed away, you had a parent that passed away, they left you their IRA. The single life table is taking into account both their date of birth, their date of death, your date of birth to determine the life expectancy or to determine the required distribution that you must take from that inherited IRA. In many cases, a surviving spouse isn't going to use that table A surviving spouse. So, for example, if I were to pass away, my wife would take my IRA balance and it would just become hers. It would roll over into her existing IRA and when she turned the age at which she had to start taking required distributions, all of it would be in one account, meaning all of the balance of her IRA and what my IRA used to be while I was still living. That's the first one, the uniform table but in this case, what we're talking about is typically it's used if you're inheriting an IRA from a non-spouse, but there are some instances where my spouse might elect that, even if I were to pass away. The first is if she's under 59 and a half and she needs access to the funds, so I pass away.
Speaker 0:Today, my wife inherits my IRA. If she were to roll that into her IRA she can't touch it she could, but she's going to pay a penalty on that, a 10% early distribution penalty, because she's not yet 59 and a half. However, if she were to inherit my IRA and she said you know what? James didn't leave me life insurance, he didn't plan for this, we don't have any money. I need to tap into his IRA balance what she would do is actually keep the IRA separate and use this single life expectancy table. It would become an inherited IRA with her as the beneficiary, and the reason for that is she would now be subject to required minimum distributions, but she would not be subject to the 10% early distribution penalty. So that's where some strategic planning comes into play of ideally she wouldn't need to access this, but if she did, this is one strategy that allows her to access those funds penalty free. She still pays taxes, but no additional 10% penalty, and she can then access those funds with no penalty and use them for her living expenses.
Speaker 0:So that's one instance in which a spouse might elect the single life table as opposed to the uniform lifetime table. The other is if the spouse who passes away is significantly younger. So let's say I'm 75 and my spouse is 63 years old, she passes away and she has an IRA. I could take her IRA and roll it over into mine, but I would immediately have to begin taking required distributions from that because that's now my IRA. I'm 75. I have to start taking distributions from the entire IRA balance because of my age. However, if I elect the single life table and choose to elect as a beneficiary IRA as opposed to move that into my IRA, I don't have to begin taking distributions until she would have reached her required minimum distribution age. So some strategy there around this of depending on the age, depending on the age gap, you may want to potentially elect that option. And this just goes back to how do you avoid that widow's tax, how do you avoid getting crushed in retirement if you don't plan correctly while you understand what options are available to you to potentially minimize some of this tax impact?
Speaker 0:And then a third part of understanding these lifetime tables is the joint and last survivor table. Where this comes into play is also if I'm significantly older than my spouse. So let's go back to that previous example I'm 75, my spouse is 63. This is what we're both living. This has nothing to do with one of us passing, but when I turned 75, I have to start taking my required distributions. Now, if I was already 75, they would have started at 73.
Speaker 0:But just to use an example, if I'm 75 and I'm taking my required distributions, if I am taking them based upon the uniform life table, that's the standard, that's what most people are doing. But what the IRS tells me is, if I'm more than 10 years older than my spouse, I can begin taking required distributions based on this joint life expectancy table and because she's so much younger, they give different numbers they have to take and actually minimizes the required distribution that I now have to take from my IRA, even if we're both living. The intention behind this is saying my IRA isn't just for me, it's really for both of us, so there's some leeway. It's a lower required amount, which allows the IRA to be preserved a bit more, because the IRS here is kind of acknowledging the fact that it's not just designed to support my lifetime but also my spouse's, who's more than 10 years younger than me. So as you start to understand these things, this is going to help you when determining what's the best strategy to maximize what your portfolio can do for you while you're both living.
Speaker 0:But also, how do you start to put a strategy in place to protect a surviving spouse?
Speaker 0:So, with all these strategies whether it's Roth conversions, whether it's your social security strategy, whether it's understanding what life expectancy tables to use when it comes to required distributions there are pros and cons to each of them. None of these is universal in its application. None of these is all good or all bad. There is so much nuance and pros and cons that make sure you're working with your financial advisor to work through some of these things. Get the Retirement Planning Academy Again link is in the show notes below if you want to model some of this out for yourself. But make sure you understand these things so that you don't go into retirement thinking you've got a great plan for you and your spouse, only to have one of you pass away prematurely and have the surviving spouse accept a much less ideal retirement than they otherwise would have had they planned for this ahead of time. But what? These three things? These are three things you can start to implement into your plan today to protect your spouse for whatever happens tomorrow.
