The Widow Penalty – It’s a Real Thing

Being a finance guy, I see firsthand the effects of today’s longer life expectancies. In the 1950’s, the average American could expect to live to about 69 years old, but thanks to significant developments in medicine, today the average retiree can expect to live to almost 80 years old – and that’s just the average₁. These days it’s not uncommon for any retirees to live well into their 80’s and 90’s, or even beyond. And while living longer is a good thing, it also means you need more money to get you through a longer retirement. If your retirement system was designed to support you for twenty years in retirement but you end up living for thirty years, you’ll find yourself in a real pickle for those last ten years.

But there’s another wrinkle that retirees need to account for – the very likely possibility that one of you will die first, leaving behind a spouse who will need both emotional and financial support, potentially for years. You might be thinking, hey, no problem – if I am the surviving spouse, my expenses will drop in half and I should be just fine with our current savings. Right?

Unfortunately, that’s not usually the case. Consider my new friend, Liz.  Liz was referred into me after her husband, Chuck, died suddenly this year. Liz explained to me that they saved diligently for decades and retired in 2021 with a nice nest egg and 2 social security checks. Chuck received $2800 each month, and Liz got $1250 – much less than Chuck because she spent fifteen years out of the workforce raising their 3 children. Along with Chuck’s $2500 pension income, they had a comfortable retirement. Regrettably that came to a halt when Chuck died suddenly. 

Liz was devastated to lose Chuck, but the financial ramifications of being a widow were shocking. She learned some distressing facts about retirement planning that she and Chuck weren’t prepared for. For starters, couples receiving Social Security income will see it reduced when a spouse dies, and the survivor receives only the higher of the two benefits. This meant that Liz’s $1250 benefit went away, and she received Chuck’s benefit of $2800 only. Adding insult to injury, Chuck’s pension stopped with his death. When he initially elected to take his pension, he chose the single life payout as opposed to a joint payout (which would have offered a lower income payment but have paid out until both Chuck and Liz died).

To make matters worse, Liz now had to file her taxes as single filer instead of a couple. The single tax rates are the highest personal income rates payable, so Liz now owed higher taxes on less income. (The surviving spouse generally can still use the higher married-couple-filing-jointly tax bracket for the next tax year, a one time “perk”). 

And folks, it doesn’t end there. Healthcare costs may also rise, as Medicare premiums are tied to income. In 2024, couples pay the standard premium of $174.70 up to income of $206,000; but single people pay it only to $103,000. Incomes above those levels are subject to steep premium bumps. 

There are other smaller costs and loss of discounts can add up as well. For example, veterans benefits such as reduced license-plate fees, property-tax reductions, or healthcare benefits will end if the deceased spouse was a veteran. Home maintenance costs may rise, especially if the surviving spouse now needs to pay for services such as lawncare or snow removal.

Couples’ discounts for insurance premiums and loyalty programs cease as well. While some costs may drop, they may not be cut in half. For example, cellphone plans may be cheaper with one less line, but the bill could still be two-thirds of what it was.

Obviously not all deaths are foreseeable, but Chuck and Liz’s story demonstrates why it’s so crucial for couples to ensure their retirement system accounts for the very real possibility that one will outlive the other and the surviving spouse’s financial situation is addressed.  

After reviewing and understanding Liz’s complete financial picture, I explained to her that she had a few moves she could still make to help reduce the “widow’s” penalties. For example, in that first year after Chuck’s death she could complete a Roth conversion of her IRA. Owners of pretax accounts can move their assets to an after-tax Roth account, and the amount converted is taxed as ordinary income. For Liz, it might make sense for her to complete a Roth conversion in this first year and take advantage of the higher standard deduction and more generous tax brackets available to married couples before her single filing status kicks in next year.

Her home in North Falmouth has significant capital appreciation and she’s considering moving or downsizing; she could sell the home and take advantage of their joint $500,000 capital-gains exemption as a couple. If she waits until after this first year when she will be a single filer, she will lose a $250,000 exemption and be able to exclude just half of the $500,000 capital-gains exemption.  

Folks, most financial professionals will encourage a surviving spouse not to make rash decisions right after a death, but it’s often crucial to meet with your retirement specialist to consider some important steps that could help ease the financial burden in the calendar year after death. The “Widow’s Penalty” is real, but with thoughtful planning you can help minimize its impact.

So as always - be vigilant and stay alert, because you deserve more!

Have a great week.  I hope everyone is having a wonderful Holiday Season.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. 

Insurance offered through its affiliate, CutterInsure, Inc. We do not offer tax or legal advice. Jeff can be reached at jeff@cutterfinancialgroup.com. This information is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Information regarding investment services is provided solely to gain a better understanding of the subject of the article. Different types of investments involve varying degrees of risk, including the potential for loss. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. Market data and other cited or linked-to content is based on generally available information and is believed to be reliable. Cutter Financial does not guarantee the performance of any investment or the accuracy of the information contained in this article. Cutter Financial will provide all prospective clients with a copy of Cutter Financial’s Form ADV 2A, Appendix 1, applicable Form ADV 2Bs and Form CRS as well as the firm privacy policy. Please contact us to request a free copy via .pdf or hardcopy. 1. https://tinyurl.com/mw9py6rj