A. Widow's penalty tax trap refers to the situation that after a spouse’s death, the survivor will eventually go from a joint return to being a single filer. The widow or widower’s tax bracket likely will rise, resulting in a plumper tax bill.This bracket creep occurs because the survivor’s taxable income may be about the same as it was on a joint return. (The reduction in taxable income from the loss of one Social Security check may will be partially or fully offset by a smaller standard deduction.)
For example, someone could go from a 24% tax bracket, filing jointly, to a 32% bracket for the survivor. The result will be thousands of dollars a year in extra tax payments. As a single filer, the surviving spouse also could owe more tax on Social Security benefits or face more exposure to the 3.8% surtax on net investment income.
How to Avoid Widow's Penalty?
First, it is important to address the widow’s penalty while both members of the couple are alive.
After age 59-1/2, but before begin taking Social Security benefits, couples could convert part of their traditional IRAs to Roth IRAs at a lower tax rate. The 10% early distribution penalty won’t apply then and the conversion would be taxed at the lower joint filing rate. Moreover, Roth IRA conversions reduce taxable RMDs from traditional IRAs after age 70-1/2.
Today’s tax rates for married couples filing jointly are relatively low, no higher than 24% on taxable income (after deductions) up to $321,450. That same income would put a single filer in the 35% bracket.
A series of partial conversions should be done over a period of years, taking care to keep the amounts within low tax brackets. For the money moved to the Roth IRA, there are no RMDs for the owner or the surviving spouse, therefore, the account can continue to grow or be used with no tax consequences.
Drawing down a reverse mortgage line of credit or taking life insurance policy loans could be other sources of cash flow that won’t trigger highly taxed income.