RMDs and the Widow’s Penalty – How to Protect Your Spouse from a Higher Tax Bill
- Bill Herr
- Oct 2, 2024
- 3 min read
RMDs and the Widow’s Penalty – How to Protect Your Spouse from a Higher Tax Bill
When it comes to retirement planning, there’s one tax trap that catches a lot of people by surprise—the widow’s penalty. It sounds ominous because, frankly, it is. If you or your spouse aren’t prepared, it can leave the surviving spouse facing a much bigger tax bill, right when they’re adjusting to a major life change. So let’s break this down and talk about what you can do to minimize this risk.
What Are RMDs?
First, let’s get clear on Required Minimum Distributions (RMDs). If you’ve got a traditional IRA or 401(k), RMDs are the minimum amount you have to withdraw each year once you hit a certain age—currently 73 (or 75 for younger folks, thanks to the SECURE Act 2.0). The catch is, those withdrawals are treated as taxable income, and if you don’t take them? You’re hit with penalties.
RMDs are designed to make sure you eventually pay taxes on your tax-deferred savings. While that sounds fair in theory, in practice, it can create a hefty tax bill during your retirement years, especially when Social Security and other income sources are factored in.
The Widow’s Penalty – What’s That?
The widow’s penalty refers to the spike in taxes the surviving spouse can face after their partner passes away. Here’s how it works:
Married Couples File Jointly: When you’re married, you get to enjoy wider tax brackets, meaning you can make more money before moving into a higher tax rate.
Single Filing Status: Once one spouse passes away, the surviving partner has to file as a single taxpayer. This means they move into narrower tax brackets and lose the benefit of the higher standard deduction that comes with joint filing. Essentially, the surviving spouse ends up paying a higher tax rate on the same or nearly the same amount of income.
The RMD Impact: The kicker? The surviving spouse typically inherits the full IRA balance of their partner, meaning those RMDs don’t just go away. In fact, they now must take RMDs on the total IRA balance, which could push them into even higher tax brackets. Combined with the new single filing status, they could end up paying significantly more in taxes—hence the term "widow’s penalty."
How RMDs and the Widow’s Penalty Work Together
Imagine this scenario: A couple in their 70s has a combined IRA balance of $1 million. Together, they’re in the 22% tax bracket and are required to take RMDs, but they’re managing just fine. Then one spouse passes away, and now the surviving spouse has to take RMDs on the full IRA, and suddenly, they’re pushed into the 32% bracket or higher.
The combination of the surviving spouse’s single filing status and the continued RMDs can result in thousands of dollars more in taxes—just when they’re facing the financial and emotional challenges of losing a partner.
Strategies to Reduce the Widow’s Penalty
Now that you see the risk, let’s talk about what you can do to avoid it:
Roth Conversions: Converting part of your traditional IRA to a Roth IRA can help reduce the future tax burden. Roth IRAs don’t have RMDs, and withdrawals are tax-free. By converting during lower-income years (or before RMDs kick in), you can reduce the size of your taxable RMDs in the future.
Filling Up Lower Tax Brackets: During retirement, particularly in those early “low-income” years, consider filling up lower tax brackets by taking additional distributions or Roth conversions. This can prevent a tax spike later when one spouse is left to handle RMDs alone.
Strategic Withdrawals: Plan your withdrawals carefully. It might make sense to take larger distributions earlier in retirement to avoid larger RMDs in later years when tax rates could be higher for the surviving spouse.
Income-Splitting: If possible, spread-out income sources between both spouses. This could involve making sure both of you have retirement savings in separate accounts. This can help to balance the RMDs and potentially lower the widow’s penalty impact.
Don’t Wait Until It’s Too Late
If you’re thinking about these issues after one spouse has passed, it's already too late. The key is to start planning early, well before RMDs begin. By being proactive, you can shield your spouse from unnecessary tax penalties and preserve more of your hard-earned savings for the future.
The widow’s penalty doesn’t have to be an inevitable financial blow. With smart planning, you can take steps now to protect your spouse, minimize taxes, and ensure your retirement savings stretch further for both of you.
Have questions about how to reduce your RMD burden and plan for your spouse’s future? Let’s talk about how to build a tax strategy that works for your family’s unique situation.
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