Losing a spouse can be one of the most emotionally difficult events anyone can experience. The Widow’s Tax—which some consider to be one of the more repulsive parts of the tax code—can add financial pain to an already emotional time. Here is how it works.
IRS tax code treats married people very differently than single people. We have one set of tax rates for single people, and a separate set of rates for those who are married. Because of this, when a spouse dies, the surviving spouse may often face a drop in income and a hike in income taxes at the same time.
Consider this hypothetical: Janet and her husband, Steve, are both 75 years old. Steve, who retired ten years ago, worked as an electrician, while Janet stayed home to raise their three children. After Steve retires, he begins to receive a monthly pension of $2,000 with a 100% survivorship benefit (meaning Janet will continue to get $2,000 per month when he passes). Steve also receives $2,000 per month in Social Security, while Janet collects a spousal benefit of $1,000 per month from Social Security.
They each have IRA accounts. They’ve been taking withdrawals from them for a combined annual amount of $25,000. That adds up to $85,000 of gross annual income. We’ll assume they take the standard deduction, which is $27,400 for those over 65, married, and filing jointly.
On December 15, 2020 Steve passes away. Janet is devastated. She lost her best friend and the love of her life. In addition to the tremendous emotional challenges she’ll face, here are some of the financial changes that Janet may not be expecting:
1) Social Security will decline
When both spouses are collecting Social Security and one passes, the surviving spouse generally receives whichever is greater: their own benefit, or their deceased spouse’s benefit. In our example, Steve was receiving $2,000 and Janet was receiving $1,000, for a combined monthly total of $3,000. She’ll switch to Steve’s benefit because it is larger than hers. She will now receive $2,000 each month, which is a loss of income of $1,000.
2) She will be in a higher tax bracket
For a couple that is married filing jointly, the top of the 12% bracket in 2020 is $80,250. For a single person, the top of the 12% tax bracket in 2021 is $40,525. Therefore, as a single taxpayer, Janet will be subject to a higher tax bracket of 22%.
3) She will lose some deductions
Janet will now be subject to the single standard deduction of $14,250. In the prior year, Janet and Steve qualified for the standard deduction of $27,400 for married couples filing jointly.
4) A larger portion of her Social Security will be subject to taxes
The amount of Social Security that’s subject to taxes is calculated using a complex formula based on adjusted gross income, 50% of Social Security benefits received, and the total of any tax-exempt interest received. Before Steve passed, roughly 70% of their Social Security was subject to taxes. Now that Janet is filing as single, 85% of her Social Security income will be subject to taxes because of her level of income.
So in our example, Janet’s actual income declines by $12,000 per year due to the reduction in Social Security benefits. But because of the factors mentioned above, her taxable income increases from $47,150 to $55,150. This results in her tax liability increasing from $5,263 to $7,882. So, the tax per person increases from $2,631.50 per person to $7,882 per person.
How the widow tax adds up
While one could argue that expenses will likely decline when a spouse passes, there are also a number of major expenses—such as housing—that stay the same. Regardless of how many people live in your house, your mortgage or rent, taxes, utilities, and homeowners insurance don’t typically change much.
When a spouse passes, it is an extremely emotional and often frightening time. You’ve spent so much time with this other person, and suddenly, you have to reimagine and redesign what your life will be like without them.
With every couple, there’s a division of labor between the different responsibilities of the house, such as yard work, laundry, cooking, bill paying, budgeting, investing, and tax preparation. The surviving spouse will either have to take over some of these tasks or hire someone to do them at an additional cost.
One thing worth mentioning is that the year your spouse passes away, you’re allowed to file as married filing jointly as long as your spouse was living for at least one day of that year. In our example, Janet’s husband passed away in the end of December. If he had passed in January, it could have been beneficial to engage in a Roth IRA conversion or additional IRA withdrawals to take advantage of her last year being subject to the married filing jointly rules (e.g. higher standard deduction, higher income tax brackets, lower Social Security income, etc.).
Summary of our widow’s tax example
The additional taxes of $2,619 and loss of income of $12,000 reduces the total of Janet’s spendable income by a whopping $14,619 per year. Knowledge is power. Work with qualified professionals to develop a plan that can help you address any gaps that you may have. It may not help with your grief, but it will almost certainly serve to reduce your stress and potentially prevent you from making some costly mistakes.
Originally published September 2016