The Retirement Tax Trap that Can Hit a Surviving Spouse

Most married couples plan for retirement together.

They talk about travel, downsizing, helping the grandkids, protecting their savings, and creating enough income to enjoy the years they worked so hard for.

But there is one retirement risk many couples do not talk about enough: What happens financially when one spouse passes away?

It is not an easy conversation. But it is an important one.  Because for many widows and widowers, the loss of a spouse can also create a retirement tax trap.

And unfortunately, this is not a rare possibility. For many couples, it is highly likely that one spouse will outlive the other. That means the financial plan should not only work while both spouses are alive. It should also protect the surviving spouse.

 

The Problem: Income May Go Down, But Taxes May Not

When one spouse passes away, the surviving spouse often loses one Social Security check. The household may keep the higher benefit, but the smaller check typically goes away. At the same time, expenses usually do not get cut in half. Some costs may decrease, but many major bills remain, including housing, utilities, insurance, property taxes and everyday living expenses...gas for example.

This creates a difficult income gap. The surviving spouse may be trying to maintain the household with less monthly income while still facing many of the same responsibilities. This is why retirement income planning should not only focus on both spouses living together — it should also answer an important question: Will the surviving spouse be financially okay alone?

 

The Standard Deduction Can Be Cut Nearly in Half

While both spouses are alive, many couples file taxes as married filing jointly.  But after one spouse passes away, the surviving spouse may eventually file as a single taxpayer.

That can create a major tax change.

The standard deduction for a married couple is much higher than the standard deduction for a single filer. In simple terms, the surviving spouse may have less income than before, but also a much smaller deduction.

 

That means more of their income may become taxable.

This can be especially painful if the surviving spouse still has required minimum distributions, also known as RMDs, from traditional IRAs, 401(k)s, or other retirement accounts.

 

RMDs Do Not Disappear When Life Changes

Many retirees are surprised by this.

Required minimum distributions are not based on whether you feel ready to take money out.  They are required withdrawals from certain retirement accounts once you reach the required age.

So even if the surviving spouse is grieving, adjusting to life alone, and trying to manage the household on one Social Security check, the IRS may still require withdrawals from retirement accounts.  Those withdrawals are generally taxable as ordinary income.

That means the surviving spouse may be facing:

• Less Social Security income
• Similar household expenses
• A smaller standard deduction
• Required withdrawals from retirement accounts
• Potentially higher taxable income than expected

That is the surviving spouse tax trap! 

This Is Why Portfolio Reviews Matter

A retirement portfolio should not only be reviewed for investment performance.  It should also be reviewed for income, taxes, survivor needs, and future risks. A strong retirement income review may help answer questions like:

• Will my spouse have enough monthly income if I pass away first?
• How much of our retirement income will be taxable?
• Could RMDs create a tax problem later?
• Should we consider Roth IRA conversions before one spouse passes away?
• Would an annuity help create guaranteed income for a surviving spouse?
• Do we have enough life insurance to protect against more than burial expenses?
• Have we planned for taxes, healthcare costs, and income gaps?

These are the kinds of issues that are easy to miss when retirement planning focuses only on account balances.

The Time to Plan Is Before the Problem Happens

The surviving spouse tax trap is not something to review after a loss.  By then, options may be limited.

The best time to plan is while both spouses are alive, healthy, and able to make decisions together.

A retirement income review can help identify potential problems before they happen. It can also help you understand whether strategies like Roth conversions, annuities, life insurance, or other income-planning tools may fit your situation.

The goal is not to scare you, the goal is to prepare you.

And when it comes to protecting the person you love, preparation is one of the greatest gifts you can leave behind.

Schedule a retirement income and portfolio review today to see whether your plan is built to protect both of you