Widow’s Tax and the Widow’s Penalty
What happens at the death of the first spouse? The Widow’s Penalty Tax. Also known as the Widow’s Tax.
In this sad event, tax implications often leave the surviving spouse worse off. Hence “penalty.”
Not only is there loss of social security income, what income remains hits higher tax brackets! Up to 85% of social security is taxable when provisional income is above $44,000 for a couple, but just $34,000 for a surviving spouse.
There are other implications as well, such as total or partial loss in pensions, but the major concern is higher tax brackets! Tax brackets for couples have much more room for income than for singles.
Let’s look at a 70 year-old couple and see what happens when a spouse dies.
Widow’s Tax and Net Worth, Taxes Due
Let’s look at a scenario to see how the widow’s tax works. Here, we have a 70 year old couple, and a spouse either dies at 73 or does not. How does that affect net worth and taxes over time?
On the top of figure 1, you can see that this couple is 70 and have a $1M net worth. In dark green, you can see a slow decrease in net worth over time with a spousal death at age 73, vs. no spousal death in light green.
Why is there a decrease in net worth? One reason is increased taxes on the widow. The Widow’s Penalty Tax!
On the bottom of figure 2, you can see how much is spent yearly in taxes. At baseline in green, the couple owe about $6,000 in taxes and this slowly increases over 30 years to $15,000.
In blue, a spouse dies at age 73, immediately increasing taxes up to $10,000 a year. You can see the widow continues to pay increased taxes over the remaining 30 years.
Let’s look and see what spousal death does to the tax rate.
Increased Taxation of the Surviving Spouse. The Widow’s Penalty
In figure 2, find 2022 on the left: the year before death. Below that is two possibilities: 2023 without and with 2023 Death of a spouse. Now we can see how the death affects the next years’ taxes.
Note that income decreases by 50% after death (due to loss of a social security check).
Taxes, however, also increase by more than $3k! What! Less income yet more taxes!
Net outflow increases to cover both increased taxes and loss of social security.
Note next social security benefits received, the amount that is taxable on their 1040s, and the percent of social security that is included in their taxable income. Due to the death of the spouse, the full 85% of social security is included after death of the spouse, when it is only 72% taxable (and double the amount) without death.
Also included is AGI and the standard deduction. I invented a ratio: the standard deduction to AGI ratio. The higher the better, because that means you have a large standard deduction compared to your adjusted gross income. Note the increase in taxable income due to the cut in half of the standard deduction.
Conclusion: Widow’s Tax or the Widow’s Penalty
In this scenario, we compare a 70 year old couple with and without the death of a spouse.
Due to the Widow’s Tax, also known as the Widow’s Penalty, there is an increase in taxation of social security and decrease in the tax brackets. This leads to an actual reduction in net worth overtime as more income is needed from the fully taxable IRA to pay taxes and expenses.
In addition, there is loss of a social security check with the Widow’s Penalty. In this scenario, social security met 43% of income needs of the couple, whereas it only meets 26% of the needs of the remaining spouse.
While variable expenses do decrease after the death of a spouse, most of the fixed needs stay the same. Most singles will find they spend about 80% of what they did prior to the death of their spouse.
Aside from the emotions, there are financial implications with the death of a spouse.
Planning for potential loss of a spouse include:
- partial Roth conversions
- social security optimization
- pension and survivor benefits
- making sure beneficiary forms are correctly filled out
- consider Life Insurance to avoid the Widow’s Penalty
Avoid the Widow’s Penalty with some advance financial planning.