The “Widow’s Tax” Trap: The Hidden Tax Reality of Losing a Spouse

Many years ago, I had a couple come into the office and we went through our entire process and we got to the point where I simply asked, do you want our help? A wife looked over to the husband and she said, honey, I think we should move forward because if anything happens to you, I don’t want to deal with this. I don’t understand what’s going on. I don’t really care that much. And most importantly, I just don’t want this on my plate. He looked at me and he said, Troy, we’re going to go home and talk about it. And I’ll let you know. So he calls you back in a couple of days and he says, Troy, I just can’t give up control.

I’m gonna do this for a few more years and then we’ll reach out to you and we’ll take care of all the planning stuff that you mentioned. So a few years goes by, I don’t hear from them and I come into the office one morning and she’s in the lobby. She says, Troy, let’s go into the conference room. And I ask her, is Gary joining us? And she says, Troy, Gary passed away. She said, for the past year, I’ve been dealing with one financial institution after the other, putting forms in, filling forms out, changing beneficiaries, changing account titles, making mistakes, spending hours on the phone, transferring money. This is exactly what I didn’t want to do. So we sat down, we started going through everything and we got to the part where we’re discussing taxes. So as we start going through her income and tax situation, the only thing that changed with the income was one social security check went away, so the smaller social security check, her check. And everything else stayed the same, the dividends, the Mutie bond income that they had, the distributions for living expenses, all of that stayed the same.

So when we looked at the taxes, her taxes went from about $8,000 a year to about $17,000 a year. So the income went down, but the taxes significantly went up. So what I’m gonna do in this video today is help you become aware of the changes that happen when one spouse passes away. Part of the retirement planning process, if this is important to you, making sure that one spouse is taken care of when you’re gone, is to understand first and foremost what happens. We have to make visible the changes in the tax code with the deductions so you understand how that would impact you financially. And then we have to address it. We have to take proactive steps, typically over a series of years, to position not just for both of your retirements to be in a position that is beneficial while you’re both alive, but when one spouse does pass away to make sure that the surviving spouse is financially comfortable.

So now I’m gonna show you how the tax went from 8,000 roughly when they were married to about 17,000 when one spouse passed away. But before we do that, just one thing to be aware of here because this is something of confusion that I hear many times when talking to people. So when one spouse passes away, the only time that you can still file Mary jointly is in the year of death. That subsequent year, the very next year, you go from MFJ to filing single. The only exception is if you have a dependent child, so somebody under the age of 18. So here we have, this is basically a summary of the income. As I said earlier, the only income that changed was the social security because one check goes away.

Filing Status Change: Married vs. Single

So we have total income of about $133,000. So standard deduction when you’re married is much higher. It’s about double than when you’re single. So $35,500. We see the total tax was about $8,600 here. Down here we have the enhanced senior deduction. So this is something that’s relatively new. It’s gonna be around for a few years, but for married people, it’s $12,000. Tax exempt interest was about $8,100. We have dividends here, no long-term capital gains. And here was the social security. Married, combined social security was 52,800. This number right next to it is the amount that’s taxable. So only 85 % of the gross social security is subject to income tax.

Then the very last thing was there was about a $60,000 IRA distribution for required minimum distributions. Most of you have asked the question or wondered the question, if something happens to you, will your spouse be okay? And that answer typically revolves around how much money you have. But a lot of times what I see is that you don’t really think about how is the entire financial picture going to change? How is the tax code going to interact with our existing income and accounts when one spouse is gone versus both of us alive? What are the interactions? So that’s what I’m trying to raise here. I’m trying to make visible the way the tax code pushes back when you do nothing at all except one spouse passes away.

Analyzing the Married Filing Jointly Tax Scenario

So I want you to think about it for one second. I’ve given you one thing that’s going to happen, which is your standard deduction gets cut in half. But what else happens with tax brackets, with thresholds, with different aspects of the tax code? I’m go through and I’m gonna show you what happens here, but I want you to think about it because what we’re trying to do here is get you to think about the bigger picture. It’s not just how much money you have, it’s where is the money? How are the decisions that I’m making today setting me up for success in the future, our family? but also setting your spouse up if something happens to you.

Analyzing the Single Filing Tax Scenario

Okay, so here is the single analysis. Again, exact same scenario, same income, except one less social security check. So 14,400 goes away for social security. Everything else stays the same. Still have to take required minimum distribution, still have the dividends, the tax-free income, social security, the big one. So here we go. So first, I just wanna point you to the total tax line. 17,659 compared to, I believe, 8,600 in the married filing jointly scenario. We see the deductions, the standard deduction drops from 35 and change to about 18,150. We’re gonna come over here, the marginal tax bracket is 22 % for the single filer, whereas going back to the joint filer, 12%.

Right below that, you have the average rate of tax being paid, 6.4 % versus 13.7 % in the single filer. Gonna come down here to the enhanced senior deduction. When they were married, they had another $12,000 deduction, but as a single filer, the only thing that’s changed is one spouse has gone away. So the enhanced senior deduction goes down significantly. Now not gonna bore you with the calculations and the phase out details, you can Google it, but the enhanced senior deduction, the result is it drops to $2,790. Still have the same tax exempt income, still have the same ordinary dividends. Then here we see the social security, we still have $38,400. 85 % of it is still subject to tax. So here’s a scenario where it doesn’t matter if they’re married, filing jointly or single because the rest of the income taxable income is at such a level, social security is still subject to 85 % or 85 % subject to income tax.

How Tax Brackets Shrink Upon Loss of a Spouse

Okay, so this was the easy one. Income tax brackets change. So here is the married filing jointly. we can have, here we see the marginal rate. So 12 % 24,000 to 100,000. So taxable income that falls within that range, up to $100,000, you’re not paying more than 12%. And keep in mind, we have a progressive tax system, so the first 24,000 after deductions is taxed at 10%. So two things happen when one spouse goes away. The deductions, which act as a cushion against the tax code because they reduce your amount of income. The bigger your deductions, the less income you have to fall into these brackets. So the deductions shrink when one spouse passes away.

But the brackets, they also shrink when one spouse passes away. We switch over here to the single brackets. Now, 12,400 versus 24,800. So that cuts in half. Now the 12 % bracket tops out at $50,400. 105,000 of taxable income, which was the top of the 12 % bracket when you’re married, filing jointly, now becomes the top of the 22 % bracket. So we see how much income is being taxed in these different thresholds. Essentially, we’re filling up these buckets, these tax buckets, much more quickly, which pushes more income through the tax system, which causes you to pay more income tax. But that’s not the only thing that changed.

Impact on Capital Gains and Dividend Tax Thresholds

Okay, so the next thing that changes is the long-term capital gains in the qualified dividend tax thresholds. So this is something that I always talk about whenever I do public speaking or I get invited to talk to a corporation. I always talk about the 0 % capital gains and why it’s so important to plan for it because if you’re married filing jointly or single the thresholds are just bigger if you’re married. You can have up to $98,900 of taxable income and pay 0 % tax on your long-term cap gains and your qualified dividends. So when they were married, the thresholds were higher, their taxable income fell within the 0 % bracket, so their dividends, qualified dividends of $10,000 were 0 % taxed. We switch over to the single here, and now look, the thresholds dropped. No longer is it 98,000, it’s 49,000, so those brackets compressed. Because the deductions are also smaller, the taxable income is higher. So she blows through the 0 % marginal rate for qualified dividends and long-term capital gains. And now 100 % of those dividends are subject to tax.

Medicare IRMA Surcharges: The Hidden Cost

Okay, so now we’re gonna go through one of the last big changes here under current tax law. But first I want you to think about what actually changes from the expense side. So one of the big myths that we’ve seen over the years of just being in practice is that the expenses don’t go down that much when one spouse passes away. Yes, certain things will reduce if you’re going out to dinner, you’re supporting one versus two people, et cetera. But oftentimes you’re in your 70s or 80s and a lot of those expenses that may go away often get replaced by healthcare expenses or they help around the house because you don’t have two people taking care of things, you just have one. So those things typically replace some of the expenses that may go away. so we don’t see them drop overall. Okay, so standard deductions, the enhanced senior deduction, the income tax brackets, the capital gains, the dividend tax brackets. Now we have the Medicare brackets. They compress as well. once you’re, so you have part B, part D premiums, which you pay, but if you have income in excess of certain thresholds, what’s called IRMA, it’s an acronym that stands for income related monthly adjustment amount. a surcharge that gets added onto your Medicare premiums and these essentially reduce your social security check, your take-home pay, because that’s where they come from. And if they take all of your social security check, you have to write a check to the government. Okay, so here’s the married filing jointly for Medicare. So up to $218,000 of modified adjusted gross income before you get into these IRMA surcharges. So IRMA, it’s an acronym, it stands for Income Related Monthly Adjustment Amount. If your income exceeds certain thresholds, they impose a surcharge on top of your Medicare premiums. So part B and part D. So when you’re married, it’s a pretty big threshold that not many people have to worry about unless you’re doing big rough conversions to deal with the IRA. Maybe you sell a home or an investment property, something like that that increases one time your income. But many of you still will have to worry about these on an ongoing basis, especially when you get into requirement on distribution phase, if you’ve saved up a million, two or more inside your retirement account.

Why Proactive Planning Matters

But the single thresholds essentially get cut in half. So this is where a lot of people get hurt, especially when it comes to being a single filer in required minimum distribution age. And I say hurt, it’s just you’re paying more taxes, right? And these IRMA surcharges, they reduce your take-home pay from Social Security. And if they take up all of your Social Security check, then you have to write the government. You have to pay the government directly. So here you see the thresholds essentially get cut in half. So once you get above 109, the surcharges start to apply to both your Part B and Part D premiums, and these can get into thousands of dollars per year. So we have all of these consequences that take place because of no action directly on your part. It’s simply the tax code pushing back whenever one spouse passes away, or the tax code interacting with life events that are beyond your control. So the goal is to be aware, to make visible these considerations so you can start to make adjustments and plan on your behalf to make sure that when you’re gone, your spouse isn’t in the same situation.