Retirement Planning and the Surviving Spouse By Rick Rodgers

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Couple Doing Retirement PlanningRetirement planning as a couple should not overlook the challenges created when the first spouse dies. Most household expenses do not get cut in half because there is only one person living. This, however, is not the case for some sources of income.

Pensions – Employer plans may offer a lump sum option but many come with an annuity income option only. The annuity distribution option is not flexible. Married couples will need to consider their pension choices carefully. The payout options vary among plans but the following choices are among the most frequently offered:

  • Life Income – This option will provide an income for as long as you live, however, the pension dies with you. Life income will give you the maximum monthly income but there are no benefits available to your spouse or heirs.
  • Joint and Last Survivor (J&LS) – With this option you will receive a pension for life and provide a survivor income for the life of your spouse. This survivor income will usually represent a percentage of your pension income – 50%, 67%, 80%, 100% are common. Keep in mind that your monthly pension will be reduced when you add a beneficiary. The greater the benefit to the beneficiary, the smaller your pension income will be to you.
  • Life Income With Guarantee Period or Period Certain (typically 5, 10, 15 or 20 years) – This option will also provide you with an income for your life, however, if you die before the end of the guarantee, the remaining payments left in this period will be paid to your beneficiary. For example: If you died in the 8th year of a 20 year guarantee, 12 years of payments would be paid to your beneficiary.
  • Joint and Last Survivor with Guaranteed Period – You may add a guarantee, as described previously, to your J&LS pension. This is an important consideration if you and your spouse want to be sure there is money payable to your estate in the event of both of your premature deaths.
  • Income Drawdown – This option is a variation on the other choices. Here the pension administrator calculates the present value of what your payments will be over your life expectancy and shows this amount as a lump sum. Each time you receive a payment, this lump sum is reduced until it reaches zero. If you were to die before the lump sum is exhausted, the balance would be paid to your beneficiary.

Social Security – Social Security benefits will also be cut at the death of the first spouse. The surviving spouse may continue to receive their benefit or take over their deceased spouse’s benefit, whichever is higher. Either way, the total received by the household will drop from a third to a half. These benefits are valuable because they increase each year with a cost-of-living adjustment and they have a preferential tax treatment. Planning will need to consider a downward revision in benefits for the surviving spouse.

Taxes – Finally the most onerous surprise is the negative tax consequences for the surviving spouse the first year they file as single. Let’s consider a couple who has $30,000 of Social Security benefits and $30,000 of other income with no itemized deductions. Only $6,850 of Social Security is subject to tax. They have 2 personal exemptions of $3,950 each and take the standard deduction of $14,800. Their total federal income tax is $1,415.

Following the death of the first spouse, Social Security benefits drop to $20,000. If the survivors other income remains $30,000, $9,600 of Social Security becomes subject to tax when this person files single. There is only one personal exemption of $3,950 and the standard deduction drops to $7,750. The surviving spouse’s tax bill jumps to $3,731! That’s more than double the tax paid filing joint and income has dropped $10,000 per year.

This is yet another reason why it is so important to save using the New Three-Legged Stool™ strategy for retirement planning. The strategy provides a means to help control taxable income and ultimately the final tax bill. Implementing this strategy is best accomplished while you are saving for retirement. Those who are already retired should look for opportunities to use Roth conversions and other tax techniques to balance their savings across all three legs.

Rick’s Tips:

  • You must carefully consider your payout options when annuity income is the distribution option from your employer plan.
  • Social Security provides spousal benefits but the final payout will be less than when both spouses are living.
  • Federal income taxes can more than double when a surviving spouse’s filing status changes from married filing joint to single.

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