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The Plight of a Retired Widow–Part 1

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Death is never fun to talk about. However, it is an inevitable part of life. In 1789 Benjamin Franklin wrote in a letter to Jean-Baptiste Le Roy, 

 

“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.

 

For married folks who are entering their retirement years Ben Franklin’s words have never rang truer. The passing of one spouse prior to the other is extremely likely. It is more often than not resulting in a widow left to deal with picking up the pieces of her life. A life that may likely extend for another decade or more. In addition to the emotional challenges of losing her lifelong partner, she will now be faced with managing new financial challenges associated with the transition from a married person filing jointly with her spouse to those of a single person subjected to the status as a Single Filer in the eyes of the government.  

Preparing for Retirement as a Married Couple

Married couples will have to wrestle with a multitude of challenges as they make the transition from their working years to their post working years. For example: 

  • They will need to structure their income and assets to replacing their pre-retirement income in order to maintain a similar desired standard of living.  
  • They will have to determine how and when to distributed their retirement assets of varying tax status to best manage taxes today and balance it with taxes in the future. 
  • They’ll need to determine when to claim social security and how to coordinate their individual benefits in order to optimize Social Security for their household as well as providing optimized benefits for the surviving spouse.  
  • They need to think through how to navigate the transition from a workplace health plan, covering both spouses, to Medicare covering the individual.  
  • They need to prepare for the corrosive impact that inflation and taxes have on their retirement assets and the ability to maintain purchasing power so vital to sustaining a consistent standard of living. 
  • They’ll need to plan for the long-term care event that is statistically likely to strike one or both spouses throughout their remaining years. 

Much preparation and attention to detail can make for a relatively smooth transition into retirement. With proper planning, their post working years can be some of their best years together. 

Conventional Retirement Planning May Create Challenges for The Survivor

Often times the planning and preparation for a successful retirement has been developed based on considerations, rules and laws applying to married couples. However, what happens when one spouse passes? As if the emotional devastation weren’t enough to deal with, the surviving spouse may be in for a really big financial shock as well. 

Married retired couples tend to settle into a lifestyle pattern. After a decade of retirement, they tend to live on a fixed spending pattern, consume a consistent portion of their retirement assets, and are accustom to a corresponding tax pattern based on their income and assets consumed. 

When a spouse passes however many things can change in a relatively short period of time. Aside from the loss of your partner, and all of the emotional devastation that comes with that. The surviving spouse will now be facing a life as a single person from the perspective of the IRS and government entitlement programs like Social Security and Medicare. 

Women Are Expected to Control $30 Trillion By 2030

According to a McKinsey and Company report released July 29th 2020 American women control just over $10 trillion of wealth in the United States. The study pointed out that about one third of women ages 56 to 74 are the primary financial decision maker in their household. That leaves two thirds of women in a married household who are currently not identified as the primary decision maker according to the study, but that is about to change. 

Over the next decade these women are projected to be the primary decision maker controlling an additional $20 trillion (for a total of $30 trillion) of household wealth as their spouses pass and cede total control of the finances to them. Just how much is $30 trillion? Nearly the size of the Congressional Budget Office’s 2030 projection of the total US Gross Domestic Product (GDP). 

Widow Filing Status May Not Be an Option for These Recently Widowed Retired Women

Retired married couples filing taxes jointly have many advantages when it comes to calculating income and corresponding taxes impacting:

  • Retirement income
  • Distributions from pre-tax retirement accounts
  • Capital gains and dividends distributed from after-tax brokerage accounts
  • Social security benefits received, and 
  • Entitlement programs such as elevated Medicare premiums 

When the first spouse passes, all of these factors can be impacted quite unexpectedly and abruptly for spouse who is not prepared for the changes. 

Surviving spouses are permitted to claim as married filing jointly for two years following the death of their spouse if you meet certain criteria. The IRS defines a “Qualified Widow” as the following:

IRS Publication 501 – page 9

Taxpayers who do not remarry in the year their spouse dies can file jointly with the deceased spouse. For the two years following the year of                   death, the surviving spouse may be able to use the Qualifying Widow(er) filing status. This filing status entitles you to use joint return tax rates and the     highest standard deduction amount (if you don't itemize deductions). It doesn't entitle you to file a joint return.

  • To qualify, the taxpayer must meet all of the following tests: 
  • Be entitled to file a joint return for the year the spouse died, regardless of whether the taxpayer actually filed a joint return that year.
  • Have had a spouse who died in either of the two prior years. The taxpayer must not remarry before the end of the current tax year. 
  • Have a child, stepchild, or adopted child who qualifies as the taxpayer’s dependent for the year or would qualify as the taxpayer’s dependent except that he or she does not meet the gross income test, or does not meet the joint return test, or except that the taxpayer may be claimed as a dependent of another taxpayer.
  • Live with this child in the taxpayer’s home all year, except for temporary absences. 
  • Have paid more than half the cost of keeping up the home for the year. 

It is fair to say that many retired widows will fail to meet ALL of the tests to file as Qualified Widow, and therefore be forced into higher tax rates, and a lower standard deduction as a Single Filer. 

What Is Likely to Change For A Retired Widow?

Income taxes are likely to increase dramatically. As a married couple filing jointly your income tax rates and brackets are substantially greater than that of a single filer. Your standard deductions are roughly double as well. After your spouse passes your standard deduction is effectively cut in half, and you’re subject to taxes rates and brackets of a single person. It’s foreseeable that your taxes will skyrocket if you plan to continue consumption of retirement income and assets in order to maintain a similar lifestyle as before. 

Adding insult to injury, any pre-tax assets like IRAs, 401Ks, and other IOUs to the IRS that were owned by your deceased spouse and left to you will impact your required distributions. Beginning at age 72 you are required to make distributions from your pre-tax accounts whether you need the income or not.  These required distributions add to your income and thus push your effective tax rate up. The IRA left to you from your deceased spouse will require distributions to be taken as well, forcing a larger distribution from pre-tax accounts at the same time as when your income tax brackets have been decreased to those of a single filer and your standard deduction is cut in half. 

Your Income Tax Rates, Brackets & Filing Status Impact Other Areas of Your Finances as Well. 

Capital gains and qualified dividends. Your income impacts the tax rates that you will pay on capital gains and dividends. If you own investable assets in an after-tax account that produces capital gains or dividends on an annual basis your income impacts the rates that you will pay. As a married couple filling jointly you pay 0% tax on long term capital gains and qualified dividends if your taxable income is under $80,000 for tax year 2020. As a single filer your income would have to stay under $40,000 for the same tax year. Short term capital gains are subject to income tax rates which will be higher for a single filer as well.   

Social Security Benefits. You’re more likely to have a larger percentage of your Social Security benefits subject to tax at a higher tax rate as a widow(er). 

Social security benefits may be subject to taxation if your provisional income exceeds certain thresholds. Provision income is calculated by adding the following together: 

50% of your social security benefit 

+ ordinary income (including distributions from pre-tax retirement accounts like IRAs) 

+ Capital Gains and Dividends (from after-tax accounts) 

+ tax free interest (from municipal bonds for example) 

= Provisional Income.

There are two sets of two thresholds for determining what percentage of your Social Security benefits are subject to tax. One for Married Filing Jointly and one for Single filers. For Married couples whose provisional income exceeds $34,000 up to 50% of their social security benefits may be subject to tax at their next highest marginal tax bracket. If their provisional income exceeds $44,000 or more up to 85% of their benefits could be subject to tax. However, for single filers the thresholds are substantially lower coming in at $25,000 and $34,000. 

A widow whose provisional income is greater because of larger forced required distributions from pre-tax accounts after age 72, and whose provisional income thresholds are lower as a result of filing as a single person, could see the percentage of her social security subject to tax jump tremendously. As a single filer she could be forced to pay an even higher tax rate on the percentage of her benefits that are subject to tax.

Medicare premiums may increase for a surviving spouse. Your current year’s Medicare Part B Premiums are based on income from two years past. For example, someone on Medicare in 2020 will be paying monthly premiums based on reported income from 2018. A married couple with an income of $174,000 or less in 2018 would pay premiums of $144.60. As income increases above $174,000 so do the Medicare premiums. For example, a couple filing jointly with an income in 2018 between $174,000 and $218,000 would see premiums jump 40% to $202.40. From $218,000 to $272,000 premiums jump to $289.20, double that of someone with an income of $174,000 of less.  

However, for single filers the income thresholds are much less. Monthly premiums of $144.60 are reserved for single filers with an income of less than $87,000, $202.40 for those with income between $87,000 and $109,000, and $289.20 for those with an income between $109,000 and $136,000. 

What, If Anything, Can You Do to Avoid the Plight of a Retired Widow(er)?

  • Planning ahead is always best. When you have time to adjust you are more likely to come out ahead than if you are hit with all of these changes unexpectedly, not to mention at a time when emotions run high and may cloud judgement. 
  • Structuring your income and assets to produce tax equilibrium throughout retirement is a start. It is possible to be too tax efficient early on in retirement. It may be more advantageous to distribute pre-tax assets earlier in retirement than waiting until later. You may consider distributing some of your IRA assets now, filling up current tax brackets, while we’re still enjoying lower rates under the Tax Cuts and Jobs Act of 2017 (TCJA) which runs through 2025. 
  • Plan how and when you claim Social Security carefully. Coordinating benefits from a household perspective as opposed to making a claiming decision as an individual is advised. Delaying Social Security to optimize the survivor benefit can ease the burden on a surviving spouse. Social Security benefits are government backed, inflation adjusted, and tax advantaged. No other sources of retirement income enjoy all three characteristics accept Social Security.  
  • Roth IRA conversion may be one of the best tools you have in order to prepare a future widow(er) against the negative financial impacts of becoming a single filer after the passing of a spouse. Because Roth IRA distributions don’t impact the taxable income in the same way distributions from traditional pre-tax accounts do (like IRAs, 401Ks and other IOUs to the IRS), you may be able to limit the impact of the issues we’ve covered in this article by converting now. Converting pre-tax money to never-taxed money under current tax laws by filling up your Joint Filing tax brackets could really easy the burden on a widow(er) later in retirement. 
  • Using Life Insurance to leave tax-free money to your spouse may also help ease the burden. Life insurance proceeds are received as federal income tax free by the beneficiary. They can be used to offset the increase expenses experienced by a widow(er) after their spouse has passed. Many life insurance policies today pull double duty as well by providing access to some of the policy benefits income-tax free to cover expenses associated with Long Term Care while you are alive. 

The Financial Plight of A Retired Widow (part 2)

Next month we’ll apply what we’ve learned in this article through practical application. We’ll explore the impact of proper planning by sharing a hypothetical story of William and Betty Johnson (not real people, or clients of our firm). 

We’ll demonstrate the financial impact when they fail to plan for the inevitable transition from married couple who are filing jointly to the survivor who is forced to file a single individual late in life. You’ll see many of the issues discussed in The Financial Plight of a Retired Widow (part 1) manifest themselves, and witness the impact of higher taxes, higher Medicare premiums, and so on.  

We’ll then see what happens if they would have applied a few planning techniques a decade or so prior in preparations for the inevitable day when one of them passes, and leaves the survivor to wrestle with the challenges of become a single person once again. 

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