There are a lot of variables to consider when deciding whether to make Roth conversions or not. I’ve addressed some of them in other blog posts (check the list below). But one thing many people miss is what Ed Slott calls the “Widow’s Penalty”. This has to do with the fact that after one spouse passes, the surviving spouse, in most cases, will be taxed as a Single and that likely means in a higher tax bracket.
How Do Taxes Work for a Surviving Spouse?
In the year of death, the surviving spouse will file as Married Filing Jointly, if desired. In most cases the following year the surviving spouse will file as single. There is one exception. The surviving spouse can file as a surviving spouse (essentially Married Filing Jointly) if the two following conditions are met:
- The spouse passed away during either of the two tax years immediately preceding the tax year
- The surviving spouse maintains a household which is the principal place of abode for a dependent child
If that exception doesn’t apply, the surviving spouse will pay taxes at the single rate
How Bad is It?
Well, as my weapons school grad friends like to say, it depends. But if you have a large amount of money in pre-tax accounts, it something you need to be concerned about. Let’s look at an example. We’ll make the following assumptions (all numbers are in 2020 dollars):
- Both spouses are age 80
- Military Pension is $75,000 per year
- SBP has been selected
- Combined Social Security is $45,000 ($30,000/$15,000)
- Pre-Tax funds equal $600,000
- Funds grow at 5%
- Required Minimum Distribution is taken on 1 Jan
- Surviving Spouse rolls funds into an IRA in his or her name (not a beneficiary account)
- Couple takes the standard deduction
- Military retiree spouse passes away at age 80
Both Age 80 (Married Filing Jointly)
Survivor Age 81 (Filing Single)
Adjusted Gross Income
If the funds in pre-tax accounts are more, the effect would be greater. Other sources of income would aggravate the situation as the married couple is a long way away from the 24% bracket and the surviving spouse is just into the 24% bracket.
What Do I Do About It?
There are other things to consider, but after ending your second career it may make sense to look at Roth conversions to fill up your current tax bracket. Tax laws are likely to change before you’re in this situation, so you’ll need to check when the time comes.
Military Finances Are DifferentYour military pension and the Survivor Benefit Program affect this calculation. If you’re working with a financial advisor that doesn’t understand your military benefits, he or she may not even consider this. We think you should work with a financial planner that you don’t have to explain your military benefits to. If you want to chat, give us a call or schedule a no-cost initial consultation.
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