The Widow's Penalty

Investment Analysis Clubs Macro Economic Trends and Risks
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This post is OT because it is a tax matter and really belongs on the Tax Board. But there are many married METARs who would be impacted.

I have heard of “The Widow’s Penalty” in regard to federal income tax. DH was a 50-year smoker until he quit early this year after a CT scan showed nodules in his lungs. (Which fortunately turned out to be scarring and not lung cancer.) Based on his COPD and loss of exercise tolerance, Google Gemini calculates a 57% chance of living 4 years and 20% chance of living 10 years. I am likely to become a widow since my cardiologist says I could live another 15 to 20 years.

I asked Google Gemini about the Widow’s Penalty.

The “Widow’s Penalty” is not an official tax or fine from the IRS, but rather a common and significant negative financial impact on a surviving spouse’s federal income tax liability and overall finances after the death of their partner.

It results from a combination of factors that typically lead to a lower household income but a higher effective tax rate for the survivor.

Here are the key reasons this “penalty” occurs:

  1. Change in Tax Filing Status

The Year of Death: The surviving spouse can usually still file as Married Filing Jointly for the entire year their spouse died.

The Following Years: The surviving spouse must eventually change their filing status.

If they have a dependent child, they may qualify to file as Qualifying Surviving Spouse (formerly Qualifying Widow/Widower) for the two years following the year of death, which uses the same favorable tax rates and standard deduction as Married Filing Jointly.

If they do not have a qualifying dependent child, they must file as Single.

The shift to Single filing status creates the main tax problem:

Compressed Tax Brackets: The income thresholds for single filers are roughly half of those for married filers. This means the surviving spouse will hit higher tax brackets (like 22%, 24%, etc.) at a much lower level of taxable income.

Reduced Standard Deduction: The standard deduction for a single filer is approximately half of the amount for a married couple filing jointly, resulting in more of the survivor’s income being subject to tax.

  1. Loss of Income Sources

The surviving spouse’s household income often drops significantly, as they lose:

The deceased spouse’s Social Security benefit (the survivor keeps only the larger of the two spousal benefits).

The deceased spouse’s employment income, pensions, or annuities (if there are no or reduced survivor benefits).

  1. Increased Taxation of Social Security Benefits

The rules for how much of your Social Security is taxable are based on your combined income and a low threshold for single filers.

For single filers, a larger percentage of Social Security benefits can become taxable at lower income levels compared to married filers.

  1. Higher Medicare Premiums (IRMAA)

The Income-Related Monthly Adjustment Amount (IRMAA) causes Medicare Part B and Part D premiums to increase for higher-income individuals.

The income thresholds for these surcharges are much lower for single filers than for joint filers. Even with reduced income, the change in filing status can push the surviving spouse above the single-filer threshold, leading to a substantial increase in Medicare costs.

In summary, the “Widow’s Penalty” is the painful financial reality where the surviving spouse has less income but is simultaneously subject to higher marginal tax rates and lower deductions due to their required change in tax filing status. [end quote]

I then input our joint income and assets into Google Gemini. Both DH and I have substantial Traditional IRAs. DH is 73 and I will be 72 in December. This brings RMDs into our taxable income.

I asked for 20-year scenarios where DH dies in 2030 and 2035 but I survive until 2045.

Long story short, the Widow’s Penalty will bite hard since all the income and the RMDs from our combined IRAs would fall into the lower tax brackets.

Google Gemini strongly suggested making Traditional to Roth IRA conversions immediately and for the years of DH’s lifetime to drain the Traditional IRAs. This would take advantage of the MFJ tax brackets (22%, 24% depending on the amount of distribution) which would not be available after DH’s death. Google helpfully generated tables and charts showing the benefit. Google included the IRMAA increase since that is also significant though nowhere near the impact of the taxes.

The cash flow hit up front is large. The benefit to the survivor widow is very large.

Every family will be different, of course. But I strongly encourage every married METAR to do this calculation.
@Goofyhoofy @AlphaWolf @VeeEnn

Wendy

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So, in other words the “widow penalty” means you pretty much go back to Single tax filer status. . As a single woman that’s been my reality for years. It always seemed a little unfair to me as the expenses for a married couple living together aren’t usually 2Xs the expenses of a single person.

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The question of tax brackets is fraught with fairness/ unfairness questions.

Many years ago there was a “Marriage Penalty.” Single people were taxed lower on the same income. That was probably because of your complaint – the expenses for a married couple living together aren’t usually 2Xs the expenses of a single person - and also way back then the husband was often the breadwinner while the wife stayed home.

DH brought the marriage penalty up in 1993 when he tried to wriggle out of getting married at the last minute. (I phoned DH’s dad in that instance and never heard anything more about the issue.)

Because of complaints about the marriage penalty, Congress re-adjusted the tax brackets beginning in 2001.

The 2025 income ranges for the 10%, 12%, 22%, 24%, and 32% brackets for Married Filing Jointly are exactly double the ranges for Single filers.

As an AARP Tax Aide volunteer, I have met low-income elderly widows who were blindsided by the loss of one of their Social Security checks when their husband died and had to move out of their apartment.

My current post is aimed at high net worth elderly couples with the opposite problem. Even if their income isn’t super-high their RMDs from their Traditional IRAs can be large. When a widow is forced to take the RMDs from both her and her husband’s IRA the tax bite can be large.

That isn’t a problem for single people like you.

Wendy

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The widow’s penalty is a key reason many financial planners use to recommend Roth IRA conversions. The general rule of thumb is that Roth IRA conversions make sense if you are converting at a lower cost than you would ultimately pay on that money if it were taken as a mandatory withdrawal (due to RMDs or inheritance distribution rules).

The thing to remember is that those total costs include direct taxes on the money, the possibility of higher taxes on Social Security benefits, and higher Medicare Part B and D premiums. It’s very possible for a widow or widower to have both a lower income and a higher total tax burden than that person had as part of a married couple. That’s especially true if the only income lost is the lower of the two partners’ Social Security benefits and the surviving spouse has no dependents and a decent amount of income from a pension or Traditional IRAs.

The reason this is true is that income taxes, taxes on Social Security benefits and Medicare IRMAA surcharges all have different trigger points for married couples vs. singles.

Regards,

-Chuck

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So I did a simple math of $2M IRA, and the RMD comes to only $75 K. At that rate the tax bite should not be very big. Right? Is there a threshold where the higher balance is a challenge?

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RMD rates increase with age. At age 85, a $2 million Traditional IRA would have a $125,000 RMD.

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The point is that the tax on the RMD is higher after one spouse’s death. The effect may not be very high when both spouses are alive but the increase adds up during the rest of the widow(er)’s entire life span.

Like the calculations for when to start taking Social Security, the calculations of when to bite the bullet on paying taxes for IRA RMDs require educated guesswork about life expectancy. This can be tough to consider for some people.

If both spouses live for the same length of time there’s no advantage to paying taxes early on IRA to Roth conversions. But if one is likely to die significantly earlier than the other the cumulative difference can be large.

Wendy

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She is 5 years younger than me! Based on family history, there is a good chance she is going to outlive me 20, 25 years. I always worried that she should not run out of money, because she ends up living into 90’s. I have never done any tax planning as we were in a very high tax bracket for sometime and most of our income was flowing through W2.

It is time I engage in some tax planning.

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If they are indeed high net worth, it may be worth having the spouse that dies first leave their IRA to a different heir (whomever the heirs may be after the second spouse dies), not to their spouse. That way, instead of the spouse taking the RMD from it over their life expectancy, the eventual heir takes that RMD over 10 years, and thus there is no increase in income from RMDs to the remaining spouse. And since either way there is no step-up in basis for IRAs, nothing is lost in the “skip a generation or two” transition. The same could apply to life insurance policies - make the beneficiary of the policy an heir different than the surviving spouse. Of course all this only applies if the surviving spouse otherwise has sufficient funds without the IRA or the insurance (“high net worth” may imply this).

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I looked into that. The way I understood is, if you are leaving it to your child, then they have to withdraw the money within 10 years. You are merely transferring the tax liability from your spouse to your child. In fact, your wife can roll it into her IRA and have ability to manage the taxes slightly better.

OTOH, I am open to transfer the money to a grandchild. But, that comes with its own challenges, starting from my son having a child, and the child’s mother may end up having some/ or total control over the distributed funds.

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Yes, that’s exactly what you are doing. However, I didn’t say anything about “child”. In fact, it would be better to choose grandchildren (or even great-grandchildren) because when you’re 85 or 90, your 60-70 year old children presumably don’t need the money, so may as well skip a generation (or two) when possible. And if you have let’s say 2 children, 5 grandchildren, and eventually 10-15 great-grandchildren, then dividing a $1-2M IRA among 5 people (or among 15 people) will usually come with a smaller tax hit, especially if the ages come out well. If the heirs of an IRA are still in their 20s/30s, then they usually are below their peak earning years and will still be in a lower marginal tax bracket.

But this was exactly the point of this post, that the surviving spouse ends up with too much RMD which pushes up to the next tax bracket, and next IRMAA bracket, etc. If the couple is indeed “high net worth”, then skipping a generation or two often makes a lot of sense … despite having to pay the taxes on that inherited IRA over 10 years instead of over life expectancy (of a usually 70+ year old person).

This is a general issue of heirs down the line (grandchildren, great-grandchildren, etc). The waters are already quite muddy (for example do you leave the same amount to the surgeon grandchild earning $500k and to the artist grandchild earning $50k), add eventual divorces into the mix and the waters get even muddier, add re-marriages and step-grandchildren into the mix, and you have veritable quicksand.

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I am not sure I am going to live that long. Still, the chances of having a grandchild who is going to have kids are very slim. Who knows, if a medical miracle happens, and I end up living that long, that would be a blessing.

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Wow, @MarkR does this describe your descendants?

Wendy

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…and there is the possibility (NOT necessarily correct, but fo me qquite persuasive) of seeing all children of the world as your progeny, and leaving a significant portion of your bounty to them in as efficacious way as you can find.

When, long ago when I was close to death from AIDS and severe depression on the death of my first husband, “g-d” (excuse the quasi-obscene familiarity of such a noun) came to me and told me I was to live, and that every endangered child on the planet was my “responsibility”.

Cannot get crazier than that, but it (ahem, pardon the obscenity again) saved me.

We all have a shared huge common progeny.

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@flyerboys I deeply admire your spirituality and idealistic love of all humanity.

For those who are less spiritual…

It is now legal to donate up to $54,000 of an IRA to a Charitable IRA Gift Annuity. This provides the tax deduction of a charitable IRA donation…but is also an annuity that pays an income stream during the annuitant’s life.

Wendy

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Nope, it was just an example. So far I have 5 kids, 1 grandchild, and another grandchild on the way (maybe even tonight or tomorrow).

My parents have 4 kids, 16 grandchildren, 1 great-grandchild, and another on the way (as mentioned above).

The point wasn’t about the exact age. The point was that when we get old and die, most of the time our own kids don’t need the money anymore at that point, THEIR kids might need the money a lot more. So, since one spouse usually does before the other, instead of “forcing” that RMD on the surviving spouse, give it to some other descendant (or charity, or whatever).

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Congrats (advanced) to you and the parents!

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On RMD, much depends on age. The first numbers are small. Often 4% or so and ratchet upward. My calcs show that RMD does not have major impact on IRA value until age 88. Until then its easy to earn more than RMD so IRA value continues to increase.

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The tax code contains many more aspects of widows penalty than you mention.

0% Capital gains moves from $80+K married to $45K or so.
NTT Obama Tax AGI moves from $250K to $200K
Estate tax exemption drops from $27.98MM this year to $13.99MM. $30MM to $15MM next year.

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So what’s the difference in the ‘Widow’s Penalty’ and a ‘Single Person’s Penalty’ again?:wink:

Pete

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