Losing a spouse is an emotionally challenging experience, and unfortunately, it often comes with financial implications as well. One such challenge is the so-called “Widow’s Tax Penalty.” This penalty refers to the increased tax burden that surviving spouses may face after the loss of their partner, and while it’s typically called the “widow’s” penalty, it can affect either spouse.

Understanding the Widow’s Tax Penalty

Surviving spouses may experience less household income, e.g., wages, Social Security, and pensions, but that income may be subject to higher tax due to a change in filing status. In the year a spouse dies, the survivor is allowed to file as a married person and use the same tax brackets and standard deductions. In subsequent years, however, the survivor files as a single person and may be subject to higher marginal tax rates and reduced deductions. This change in filing status creates the “Widow’s Tax Penalty.” This disparity can result in a significant reduction in the after-tax income of the surviving spouse, adding to the financial burden during an already difficult time.

Take a hypothetical couple – Mary and John — whose tax filing status is “married filing jointly.” In the year following Mary’s death, John’s filing status changes to single. Let’s review the impact of this change. When calculating taxable income in 2023, married couples get to deduct $27,700 but singles only deduct $13,850. While the couple – filing jointly — could stay in the 12% tax bracket until their taxable income reached $89,450, John – filing solo – would get bumped to a higher bracket if his taxable income exceeds $44,725. A potentially higher tax bracket, coupled with the loss of Mary’s Social Security check and the reduction or elimination of other income Mary might have received, means John would pay higher taxes AND receive less net income. Alternatively, if income remains the same or even increases (e.g., investment income from life insurance death benefits, 100% survivor pension benefit), John might have to pay more for Medicare premiums. The Medicare premium surtax is based on income from all sources and marital status, and if John continues to receive a high percentage of the income he and Mary shared previously, he could pay the same amount or more of the surtax than he did when Mary was alive.

Minimizing the Effects of the Widow’s Penalty

The Widow’s Penalty can be a hardship during an already stressful point in a surviving spouse’s life and, short of remarrying, it may be unavoidable. However, surviving spouses can employ certain strategies to minimize its impact:

Tax Planning and Filing Status. One effective way to mitigate the effects of the Widow’s Tax Penalty is through careful tax planning. In addition to married or single, there are other filing categories. If specific requirements are met, filing as a qualifying widow(er) for two years post-death is more beneficial than filing as a single individual. Consult with a qualified tax professional who can guide you in choosing the most advantageous filing status and help you navigate the complexities of tax laws and deductions.

Income and Investments. Careful management of income and investments can help reduce the tax burden. For example, spreading out distributions from retirement accounts over a longer period may help keep you in a lower tax bracket. Additionally, diversifying investments to include tax-efficient options, such as index funds or tax-managed funds, can help minimize the tax impact on your investment returns.

Charitable Giving. Making charitable donations can have dual benefits for surviving spouses. By contributing to qualified charities, you not only support causes close to your heart but also potentially reduce your taxable income. This may be a great opportunity to honor a cause your loved one was passionate about. Work with your financial advisor to explore tax-efficient charitable giving strategies, such as donor-advised funds and qualified charitable distributions from retirement accounts.

Health Savings Accounts. If you are eligible for a Health Savings Account (HSA), take advantage of it. HSAs offer triple tax advantages: contributions are tax deductible, earnings grow tax-free, and withdrawals are tax-free when used for qualified medical expenses. Contributing to an HSA can help reduce your taxable income while providing funds for healthcare expenses.

Estate Planning and Trusts. Proper estate planning is crucial for all individuals, but it holds particular significance for surviving spouses. Working with an estate planning attorney, consider setting up trusts that can provide income and support to the next generations while offering potential tax advantages. This is also an optimal time to consider which assets are better used for the survivor’s cash flow and which assets are best to pass to the next generation.

By understanding the implications of the Widow’s Tax Penalty and employing effective strategies, it is possible for surviving spouses to preserve financial stability. Careful tax planning, managing income and investments, charitable giving, using tax-advantaged accounts, and incorporating proper estate planning techniques are just some ways spouses can navigate the complexities of the tax system and optimize their financial situation.

Because every individual’s financial circumstances are unique, you may want to consult with qualified professionals, such as a tax or financial advisor and an estate planning attorney, to tailor strategies to your specific needs. By taking proactive steps and seeking expert guidance, you can help minimize the impact of the Widow’s Tax Penalty – and the headaches associated with it — as you navigate the challenges of life after losing a spouse.

This is intended for informational purposes only and should not be construed as personalized financial or investment advice. Please consult your financial and investment professional(s) regarding your unique situation.

Author Allison A. Alexander Financial Advisor

Allison has been involved in the financial services industry since 1985. She is a member of the American Institute of Certified Public Accountants, the Illinois Certified Public Accountant Society, and the Institute of Divorce Financial Analysts.

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