How to avoid a “survivor's penalty” before a spouse dies

  • After the death of a spouse, the survivor may face higher future taxes when converting to a single filer for federal taxes.
  • But you can minimize the potential tax hit through advanced planning, such as Roth IRA conversions, account ownership and beneficiaries.

Jesse Casson | Digital Vision | Getty Images

It's hard to lose a spouse, and a costly surprise makes it even harder, especially for older women – higher taxes. But financial experts say there are several ways to prepare.

In 2022, there is a gender life expectancy gap in the United States of 5.4 years. To the data From the Centers for Disease Control and Prevention. The average life expectancy at birth was 74.8 years for males and 80.2 years for females.

This gap often results in a “survivor penalty” for older married women, which can result in higher future taxes, certified financial planner Edward Jastrheim, chief planning officer at Heritage Financial Services in Westwood, Massachusetts, previously told CNBC.

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In the year a spouse dies, the survivor can file taxes jointly with his or her deceased spouse, known as “married filing jointly,” unless they remarry before the end of the tax year.

Next, many older survivors file taxes on their own with “single” filing status, which may include higher marginal tax rates, due to smaller standard deduction and tax brackets, depending on their status.

For 2024, the standard deduction for married couples is $29,200, while single filers can claim only $14,600. (The rates use “taxable income,” which is calculated by subtracting the greater of your standard or itemized deductions from your adjusted gross income.)

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Higher taxes could be the “biggest shock” for widows — and it could be worse once the individual tax provisions from legislation signed by former President Donald Trump expire, George Gagliardi, a CFP and founder of Coromandel Wealth Management in Lexington, Massachusetts, previously told CNBC. .

Before 2018, the individual tranches were 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. But through 2025, five of these categories will be lower, at 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

Typically, the surviving spouse inherits the deceased spouse's individual retirement accounts, and the so-called required minimum distributions are about the same. The surviving spouse now faces higher tax brackets, Gagliardi said.

“The bigger the IRAs, the bigger the tax problem,” he said.

Experts say some surviving spouses may face higher taxes in the future, but it's important to run tax projections before making changes to the financial plan.

Couples may consider partial Roth IRA conversions, which transfer a portion of pre-tax or nondeductible IRA funds to a Roth IRA for future tax-free growth, Jastrim said.

It is often best to do this over a number of years to minimize the total taxes paid for Roth conversions.

George Gagliardi

Founder of Coromandel Wealth Management

The couple will owe upfront taxes on the amount converted but may save money at more favorable tax rates. “It's often best to do this over several years to minimize the total taxes paid for Roth conversions,” Gagliardi said.

It's always important to keep account ownership and beneficiaries up to date, and failure to plan can be costly for the surviving spouse, Jastrim said.

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Typically, investors realize a capital gain based on the difference between the selling price of an asset and its “basis,” or original cost. But when one spouse inherits assets, they get what's known as a “step-up in basis,” meaning the value of the asset on the date of death becomes the new basis.

The missed opportunity for advancement could mean higher capital gains taxes for survivors.

Edward Gastrem

Chief Planning Officer at Al-Turath Financial Services Company

That's why it's important to know which spouse owns each asset, especially investments that may be “highly appreciative,” Jastrim says. “The missed opportunity for advancement could mean higher capital gains taxes for survivors.”

If the surviving spouse expects to have enough savings and income for the rest of their lives, the couple may also consider non-spouse beneficiaries, such as children or grandchildren, of tax-deferred IRAs, Gagliardi said.

“If planned properly, it can reduce the total taxes paid on IRA distributions,” he said. But non-spousal beneficiaries need to know the withdrawal rules for inherited IRAs.

Before the SECURE Act of 2019, heirs could “roll over” IRA withdrawals over their lifetime, reducing the tax liability from year to year. But some heirs now have a shortened timeline due to changes in the minimum required distribution rules.

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