In the hierarchy of stressful life events, losing a spouse consistently ranks as the most traumatic crisis most individuals will ever experience. It’s not uncommon for widows and widowers to feel confused and fearful, or even guilty that they didn’t die first. For that reason, financial advisers often recommend that surviving spouses postpone making major financial decisions, such as selling the house, until they’ve had time to process the loss.
For the most part, that’s good advice. However, surviving spouses who want to avoid an unfortunate phenomenon known as the widow’s (or widower’s) penalty may need to take steps relatively quickly to avoid a significantly higher tax bill.
The widow’s penalty occurs when a surviving spouse’s tax status reverts from married filing jointly to single. If you’re a widow or widower, you can file a joint tax return for the year of your spouse’s death. But after that, you’ll be required to file as a single taxpayer unless you have dependent children (surviving spouses with dependent children are eligible for the benefits of joint filing for up to two years after the death of the first spouse).
In many cases, switching to single filing status could result in a higher tax bill, even if your income remains the same — or even if it declines because of changes in your Social Security and pension benefits after your spouse dies. The tax hit can be particularly severe if you’re required to take minimum distributions from an IRA, because you could end up paying higher tax rates on the same amount of income you received while your spouse was alive.
For example, in 2024, a married couple who file jointly with up to $383,900 in taxable income qualify for the 24% tax bracket, but a single filer with the same amount of taxable income will jump into the 35% tax bracket. “The tax scenario in our country assumes a single person makes half of what a married couple make, but it’s not that way in real life,” says Ed Slott, founder of IRAhelp.com.
As a surviving spouse, you have the option of rolling your deceased spouse’s IRA (or IRAs) into your own IRA, which will postpone required minimum distributions if you’re younger than 73. Eventually, though, you’ll have to take RMDs from the combined account and pay taxes on the withdrawals.
In addition to shifting you into a higher tax bracket, those distributions could trigger a high-income surcharge on your Medicare Part B and Part D premiums. Even if you put off RMDs, “this is a tax that has to be paid,” Slott says. “It’s not if, but when.”
Neutralizing the tax hit
The most effective way to mitigate the widow’s penalty is to take advantage of your joint filing status in the year of your spouse’s death. Slott recommends using that window to convert as much of your traditional IRA as possible to a Roth. You’ll pay taxes on the conversion but at a lower rate than you’ll pay as a single filer, he says. More significantly, withdrawals from a Roth are tax-free as long as you’re 59 1/2 or older and have owned a Roth for at least five years, and you won’t be subject to RMDs.
Because converting to a Roth will increase your modified adjusted gross income (your adjusted gross income with certain deductions added back in), a large conversion could eventually trigger the Medicare high-income surcharge, which is based on your MAGI from two years prior to the current year; the 2024 surcharge, for example, is based on your 2022 MAGI. However, that will be a one-time hit to your Medicare premiums, notes Slott, because future withdrawals from a Roth won’t affect the surcharge. “It’s one year versus the rest of your life,” he says.
Another tax-saving option for surviving spouses who have sufficient income from other sources is to disclaim all or a portion of the deceased spouse’s IRA, says Jeremy Finger, a certified financial planner with Riverbend Wealth Management in Myrtle Beach, S.C. In that case, the funds will go to contingent beneficiaries — typically adult children — instead of the surviving spouse. Although in most cases the contingent heirs will be required to empty the account in 10 years, this strategy could make sense if their tax bracket is lower than yours, Finger says.
However, if your adult children are in a higher tax bracket — which could be the case if they’re in their prime earning years — it may make sense to hold on to the IRA and leave your heirs assets in a taxable account, which are eligible for a step-up in basis.
A step-up in basis for taxable accounts
When a spouse dies, the surviving spouse will likely be able to take advantage of a generous tax break known as a step-up in basis. This occurs when the cost basis for taxable assets, such as stocks and mutual funds, is “stepped up” to the investment’s value on the day of the original owner’s death.
For example, if your spouse originally paid $50 for a share of stock and it was worth $250 on the day he or she died, your basis would be $250. If you sell the stock immediately, you won’t owe any taxes; if you hold on to it, you’ll only owe taxes (or be eligible to claim a loss) on the difference between $250 and the sale price. If the taxable assets were jointly owned, 50% of the value of the assets will receive the step-up, unless you live in one of the nine community-property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin — in which case 100% of shared assets will receive the step-up.
Make sure to notify your brokerage firm (or firms) of your spouse’s death so your assets receive the step-up. While most brokerage firms do this automatically, it may be overlooked, particularly if you and your spouse had different surnames. That could lead to an unexpected tax bill if you decide to sell some of your appreciated investments.
The step-up creates several opportunities for surviving spouses, Finger says. If you need cash to cover expenses (or to pay taxes on a Roth conversion), you can sell funds in your taxable account without triggering a big capital gains tax, he notes. Similarly, if you want to rebalance the account, you can sell stocks or funds and reinvest the money without generating a large tax bill.
Selling your home
After your spouse’s death, you may consider selling the family home so you can live closer to children and grandchildren or downsize to a smaller home. This isn’t a decision to take lightly, but if your home’s value has appreciated significantly over the years, you may not want to wait too long to sell.
Those who have owned a home as a primary residence for at least two out of the past five years are eligible for a capital gains exclusion of up to $250,000 if they’re single, but married couples who file jointly can exclude up to $500,000. Surviving spouses are eligible for the full $500,000 exclusion if they sell their home within two years after the date of the first spouse’s death and haven’t remarried, says Allison Alexander, a CFP and certified public accountant with Savant Wealth Management in Rockford, Ill.
Even if you miss the two-year window for the $500,000 exclusion, you can still benefit from the step-up in basis of the value of the home. For a couple who owned the home jointly in a state that doesn’t have community-property rules, Alexander says, the new cost basis for the home would be 50% of its value on the date of your spouse’s death, plus half the purchase price and half the cost of capital improvements since the home was purchased.
Alexander offers this example: Suppose you and you spouse own a home jointly that you purchased for $150,000, you make improvements over the years that cost $100,000, and the market value of the home when your spouse dies is $900,000. The new cost basis will be $575,000. If you sell the home for $900,000 within two years of your spouse’s death, the entire $325,000 gain will be excluded from taxes.
If you sell the home for $900,000 more than two years from the date of your spouse’s death, the exclusion will be $250,000, resulting in a taxable gain of $75,000. (This example doesn’t take into account closing costs or any additional capital improvements you make after your spouse dies, both which will reduce the amount of capital gains.)
A checklist for surviving spouses
These steps will help you settle your late spouse’s estate and put your own finances in order.
- Ask the funeral home for 15 to 20 copies of the death certificate, which you’ll need to provide to various financial institutions to document the death. This will save you the trouble of going back for more copies if you run out.
- Notify the Social Security Administration. In many cases, the funeral home will do this for you as long as you provide your spouse’s Social Security number. If you need to reach out to the SSA yourself, call 800-772-1213 between 8:00 a.m. and 7:00 p.m. Monday through Friday or visit a Social Security office (find your local office here). You can’t report a death online. Surviving spouses are eligible for a one-time death payment of $255.
- If your spouse had a Medicare Advantage and/or Part D prescription-drug plan, report the death to the providers so you won’t continue to be charged for the plans. This step isn’t necessary if your spouse had original Medicare, because Social Security will report the death. However, if your spouse had a Medigap policy, contact the policy provider.
- Contact your spouse’s employer (or former employer, if your spouse was retired) to determine whether you’re eligible for any benefits, including a pension, 401(k), health savings account or company-provided death benefits.
- Take steps to prevent identity thieves from opening accounts in your late spouse’s name. Send copies of the death certificate to your spouse’s credit card providers with a request to close the accounts. You should also send copies of the death certificate to the three major credit-reporting companies (Equifax, Experian and TransUnion) and request a freeze on your spouse’s credit reports. Ask your state’s department of motor vehicles to cancel your late spouse’s driver’s license.
- Close e-mail and website accounts — especially accounts with Amazon, PayPal and other entities that are linked to a credit card or bank account. Talk to the providers of your spouse’s IRAs and other tax-deferred accounts about required minimum distributions. If your spouse was subject to RMDs and died before taking the required distribution for the year, the beneficiary must take it by year-end. If you’re the beneficiary, you must take the RMD even if you roll your spouse’s IRA into your own account.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
