Sep 20, 2019 4 min read

There are often grave financial consequences following the death of a spouse. Income goes down because one Social Security benefit will be lost.

The good news is, it will be the smaller one.

If a couple was receiving a pension, it will often be cut in half or disappear. While lost income can be significant, expenses usually go down only a little. This is because so many expenses stay the same whether one or two people are living in the household. Utility costs stay the same, as do property taxes or rent. If you need a new roof, you do not get a 50% discount because of a death. You may even have to hire someone to do the work the deceased spouse performed.

One major expense could go up dramatically, and many couples do not consider this when creating a financial plan. It is an increase in the amount of income taxes the surviving spouse must pay. While the tax code is gender neutral, this problem affects women much more than men because 80% of wives outlive their husbands.

The so-called “Dreaded Widow’s Penalty” can have a huge negative impact on a survivor’s finances. The tax code treats single and married individuals differently. Once you are widowed, you are single. The year the death occurs, the taxpayer can still use the married filing jointly category. Every year afterward, the filing status is single.

Under the new tax code, about 90% of people use the standard deduction. It is $24,400 for a couple and $12,200 for a single person. This is money you can receive free of any tax. On top of this, all of the tax brackets are cut in about half. This means you will likely reach higher tax brackets than you did while married.

Social Security is taxed in a unique way. It can be tax-free, 50% taxed or 85% taxed, depending on your provisional income. This is all of your other income sources plus half of your SS benefit. It you own any municipal bonds, their earnings are included even though they are considered income tax-free.

Married couples pay on 85% if their income that is over $44,000. Single people pay on 85% at $34,000. It is important to remember this percentage is the amount of SS subject to your tax rate. The government does not take 85% of the total income.

Also, many people do not realize that your Medicare Part B & D premiums can have a surcharge if your income is too high. For an individual, it is income over $85,000. The government looks at a tax return that is two years old to determine this surcharge.

It is easy to exceed theses limits when taking a lump sum, or for people with big 401(k) or individual retirement account balances when they are forced to take out required minimum distributions.

Let’s look at a real-life case. A married filing jointly couple over 65 has John’s SS of $20,000, Sally’s SS of $10,000 and an IRA distribution of $30,000. On this $60,000 of income, they pay $988 in federal income tax. Then John dies.

The year after John’s death, Sally receives John’s SS of $20,000, but no longer gets her own benefit of $10,000. Because she knows many costs remain the same, she withdraws an extra $10,000 out of the IRA. This gives her the same gross income of $60,000. Her tax bill, however, increases to $5,357, or a 442% increase. Instead of having the same amount to spend, she actually has more than $4,000 less!

It is very important to have a holistic financial plan. It can help you to prepare for all of life’s financial surprises. Unfortunately, most people are not ready.

Gary Boatman is a Monessen-based certified financial planner and the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.