The Widow’s Penalty
By: Kelley Tom, CFP®, MBA, CDFA®
After grieving a loss of a partner, what could be worse than being hit with a “widow’s penalty?” As horrible as that sounds, it’s a common occurrence. A recently windowed woman called in shock saying that her Medicare premium would be increasing significantly. On top of that, her accountant said that she’d be in a higher tax bracket for the upcoming year. She was in disbelief that although her income was decreasing resulting from reduced social security benefits and having one less pension that she’d be penalized. Why did this happen?
Reduced Income, Increased Taxation
With the passing of a partner, the surviving spouse normally sees a reduction in overall income that’s attributed to the loss of one Social Security benefit (the higher of the two is maintained) and the loss of any income sources directly linked to the deceased. These income sources may have been from employment, single life annuity payments or pensions with reduced or no survivor benefits.
Despite the loss in income, and with the surviving spouse’s change in tax filing from married filing jointly to single, there is a higher tax liability. How does this happen? Taking 2023 as an example, a single filer will fall into the 22% tax bracket at $41,775 in income, however, joint filers don’t exit the 22% tax bracket until earning more than $83,550 in income. The “widow’s penalty” comes into play in this scenario as the surviving spouse’s tax bracket becomes higher as a single filer despite income not significantly changing.
Unfortunately, that’s not the only tax that may increase. Social Security benefits may be taxed at a higher rate as taxes are based on income and filing status.
Medicare Premium May Increase
It doesn’t end with higher taxes. Similar to how surviving spouses may see an increase in taxes, they may also encounter higher Medicare premiums due to the Income-Related Monthly Adjustment Amount (IRMAA). IRMAA is an amount that’s paid in addition to Medicare Part B or Part D premiums if Modified Adjusted Gross Income (MAGI) is above a certain level. For 2023, there is no additional “surcharge” for single filers with a MAGI equal to or below $97,000, and joint filers with a MAGI equal to or below $194,000. This means that a couple with a combined income of $150,000 does not pay a higher premium, while a surviving spouse with a $100,000 income sees a premium increase around $1,000 annually.
Mitigating the Impact of the Widow’s Tax
Although no one wants to think about these situations, the most important advice that I can provide is to plan as early as possible. This provides you with the ability to make the full use of your current and future tax brackets and allows enough time to adjust your plans should any major changes happen.
The year that a spouse passes away is usually the last year that the widowed can benefit from the married filing jointly tax bracket. This can be maximized by withdrawing from pretax retirement accounts such as a 401k or Traditional IRA, or by converting those accounts to a Roth IRA.
Putting this into practice, one of my clients who was retired planned to receive Social Security benefits and start withdrawing from his retirement accounts at age 70. We knew that his income would significantly increase the year that he turned 70 and he was worried about falling into a higher tax bracket. By planning and forecasting, we were able to convert $40,000 per year from his Traditional 401k to a Roth IRA during the 5 years prior to turning 70. This allowed my client to make full use of the 22% joint tax bracket. Even though his income will increase with RMDs and Social Security at age 70, his tax bracket will remain at 22% instead of increasing to a higher one. With this strategy, my client will save a large amount in taxes and much of his money avoids the dreaded “widow’s penalty.”
While the loss of a spouse is a topic that no one wants to plan for, you don’t want to end up regretting not planning for it. Have a conversation with your Certified Financial Planner® about how the loss of a spouse may affect your financial plans. They can assist you in identifying personalized strategies so that you don’t end up with the “widow’s penalty.”