Compared to past joint tax return filing with their deceased spouse, a surviving spouse may land in a higher marginal tax bracket – referred to as the “widow’s penalty.” Unfortunately, the Tax Cuts and Jobs Act (TCJA) has made the widow’s penalty more severe in many instances.
With this in mind, clients, even in their 70s or 80s, may consider greater traditional IRA withdrawals or Roth IRA conversions as a means to take advantage of preferable marginal tax rates. It is important to act while both spouses are alive.
For example, let’s say a 75-year-old couple has Required Minimum Distributions, rental property income, portfolio income, and Social Security income that amount to $190,000 in taxable income. This lands them squarely in the 24% marginal federal tax bracket in 2019.
In this example, if the husband passes away, the wife would step into his larger Social Security benefit, and all other income items remain the same. However, her standard deduction is cut in half, and the widow, still with $175,000 in taxable income, suddenly finds herself in the 32% marginal tax bracket. Assuming she remains unmarried, she would carry with her a widow’s tax penalty every year for the rest of her life. Additionally, she could be subject to higher “phantom” taxes on Social Security income, premiums for Medicare, and exposure to the net investment income surtax.
To potentially avoid this widow’s penalty pitfall, couples can plan ahead and either accelerate IRA withdrawals to fill up their current marginal tax bracket or consider partial Roth IRA conversions. If they do not need the IRA distributions to live and have outside funds to pay the income tax on a Roth IRA conversion, it could make sense.
Since many married couples are likely to be impacted by the widow’s penalty, we would be happy to discuss these concepts with you and collaborate with your tax preparer to develop an optimal strategy.
Please note that this is not to be considered tax or legal advice.