How to avoid the ‘survivor’s penalty’ before a spouse passes

It’s hard to lose a spouse, and a costly surprise makes it even more difficult, especially for older women — higher taxes. But financial experts say there are several ways to prepare.

In 2022, there was a 5.4-year life expectancy gap between U.S. sexes, according to data from the Centers for Disease Control and Prevention. Life expectancy at birth was 74.8 years for males and 80.2 years for females. 

The gap often leads to a “survivor’s penalty” for older married women, which can trigger higher future taxes, certified financial planner Edward Jastrem, chief planning officer at Heritage Financial Services in Westwood, Massachusetts, previously told CNBC.

The year a spouse dies, the survivor can file taxes jointly with their deceased spouse, known as “married filing jointly,” unless they remarry before the end of the tax year.

After that, many older survivors file taxes alone with the “single” filing status, which may include higher marginal tax rates, due to a smaller standard deduction and tax brackets, depending on their situation.

For 2024, the standard deduction for married couples is $29,200, whereas single filers can only claim $14,600. (Rates use “taxable income,” which is calculated by subtracting the greater of the standard or itemized deductions from your adjusted gross income.)

Higher taxes can be “the biggest shock” for widows — and it may be even worse once individual tax provisions sunset from former President Donald Trump’s signature legislation, George Gagliardi, a CFP and founder of Coromandel Wealth Management in Lexington, Massachusetts, previously told CNBC.

Before 2018, the individual brackets were 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. But through 2025, five of these brackets are lower, at 10%, 12%, 22%, 24%, 32%, 35% and 37%.

Typically, the surviving spouse inherits the deceased spouse’s individual retirement accounts, and so-called required minimum distributions are about the same. But the surviving spouse now faces higher tax brackets, Gagliardi said.

“The larger the IRAs, the bigger the tax problem,” he said.

Some surviving spouses may face higher future taxes, but it’s important to run tax projections before making changes to the financial plan, experts say.

Spouses may consider partial Roth IRA conversions, which transfers part of pretax or nondeductible IRA funds to a Roth IRA for future tax-free growth, Jastrem said.

The couple will owe upfront taxes on the converted amount but may save money with more favorable tax rates. “This is often best done over a number of years to minimize the overall taxes paid for the Roth conversions,” Gagliardi said.

It’s always important to keep account ownership and beneficiaries updated, and failing to plan could be costly for the surviving spouse, Jastrem said.

Typically, investors incur capital gains based on the difference between an asset’s sales price and “basis,” or original cost. But when a spouse inherits assets, they receive what’s known as a “step-up in basis,” meaning the asset’s value on the date of death becomes the new basis.

That’s why it’s important to know which spouse owns each asset, especially investments that may be “highly appreciated,” Jastrem said. “A missed step-up opportunity could mean higher capital gains taxes for the survivor.”

If the surviving spouse expects to have enough savings and income for the remainder of their life, the couple may also consider beneficiaries other than the spouse, such as children or grandchildren, for tax-deferred IRAs, Gagliardi said.

“If planned correctly, it can reduce the overall taxes paid on the IRA distributions,” he said. But nonspouse beneficiaries need to know the withdrawal rules for inherited IRAs.

Before the Secure Act of 2019, heirs could “stretch” IRA withdrawals over their lifetime, which reduced year-to-year tax liability. But certain heirs now have a shortened timeline due to changes in required minimum distribution rules.