Does Your Retirement Plan Protect Against the ‘Survivor Trap’?

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Does Your Retirement Plan Protect Against the ‘Survivor Trap’?

Is your spouse at risk due to a lack of retirement planning? Here, CKS Summit Group explains how you can financially protect your loved one from falling victim to the “widow’s penalty”.

For many, planning for retirement involves sitting down with a spouse to discuss the ins-and-outs of their golden years – together. However, life doesn’t always work out that way, and many couples avoid or forget to talk about what their finances will look like when one spouse passes away and the other is left alone.

Data say that in 75% of married couples one spouse will outlive the other by at least five years. In about 50% of couples, one spouse will outlive the other by at least 10 years. A retirement plan that doesn’t plan for widowhood could easily go off track if the worst should happen.

“The Survivor Trap”, also known as the “Widow’s Penalty” is a financial burden facing millions of Americans. And taxes play a huge part…

When both spouses are alive, the couple’s tax return filing status is married filing jointly. However, when a surviving spouse transitions to being a single filer on his or her income tax return, it often results in having to pay more in income taxes.

Taxpayers who are married filing jointly stay in the 12% tax bracket until their taxable income exceeds $80,250 in 2020. But a single taxpayer stays in the 12% bracket only until taxable income exceeds $40,125. The 22% tax bracket applies to a married couple filing jointly until taxable income exceeds $171,050 but for a single taxpayer the ceiling is taxable income of $85,525. A surviving spouse is allowed to use the married filing jointly filing status only for the year in which the other spouse died. The special surviving spouse status can be used for a few years but only if there is a dependent child in the household.

What’s more, when a spouse passes, the smaller of the couple’s two Social Security checks automatically goes away. For example, if one spouse was getting $1,700 a month and the other was getting $2,100, the surviving spouse would get only $2,100. That additional $1,700 monthly check would disappear.

There can be a third hit to the surviving spouse. Higher-income Medicare beneficiaries are subject to the Medicare premium surtax, also known as IRMAA (income-related monthly adjustment amount).

As with income taxes, the Medicare premium surtax changes with marital status. A single taxpayer with the same income as a married couple will pay twice the Medicare surtax as the couple. A newly-widowed taxpayer who retained a high percentage of the couple’s previous income could pay as much or more of Medicare premium surtax as the couple paid jointly.

In general it doesn’t matter which spouse passes away first. The results are very similar for both.

Doing some planning while both spouses are alive is the best time to mitigate the impact of the above situations in later years. They include (According to Kiplinger.com):

  1. Understand how Social Security benefits work for married couples: Make the most of claiming strategies that can help maximize the benefit the surviving spouse will receive.
  2. If one or both spouses will receive an employer pension, look at how you can maximize that benefit, as well: Ask your plan administrator about each available payout option, and run through various scenarios to determine how each option would affect a surviving spouse.
  3. Consider converting money from tax-deferred retirement accounts (401(k)s, traditional IRAs, etc.) to a Roth IRA: A series of partial conversions could be done over a period of a few years to avoid creeping into a higher tax bracket. If the money is in a Roth account, the surviving spouse won’t have to worry about paying taxes on necessary withdrawals or having to take required minimum distributions at age 72.
  4. Prepare for life alone: Make sure the beneficiary designations are correct on any insurance policy or account that could be inherited. Both spouses should know where any important documents are kept and what account numbers and passwords may be needed for access. And both spouses’ names should be on utility bills, leases, titles, etc. 
  5. Don’t let debt become a burden: Try to pay off any debts (credit card accounts, mortgages and other loans) that could cause a financial strain for the surviving spouse.
  6. Consider purchasing or upgrading your life insurance policies: Most life insurance payouts are tax-free, so the surviving spouse can use the money for income replacement and avoid the widow’s penalty.
  7. Have a plan: And make sure both spouses take part in any financial decision-making.

Overall, the widows’ penalty is an often unexpected and unwelcome surprise to those who haven’t had to deal with the disadvantages of being a single filer in many years.

This “Survivor Trap” requires a pretty complicated strategy, and one that will be based entirely upon individual circumstances. That’s why it’s always best to work out this kind of strategy with a trusted retirement income advisor.

Contact the CKS Summit Group team here today to ensure that your financial plan is customized and tax sensitive for whatever tomorrow may bring.