Financial Planning Considerations after the Passing of a Spouse

Financial Planning Considerations After the Passing of a Spouse

The loss of a loved one is an especially difficult time and the number of changes that occur financially doesn’t make this period any easier to get through.  The goal of this post is to review the financial planning considerations after the passing of a spouse to hopefully make this time a little bit easier for anyone facing this stage of life.

Social Security

When a spouse passes away there will be a reduction in the Social Security benefit owed but not necessarily equivalent to the deceased spouse’s benefit.  The Social Security Survivor Benefit allows the surviving spouse to continue to receive the higher of the two benefits at this time.

If the spouse that has passed away had not claimed their benefit and was the higher earning spouse, the surviving spouse will still have the ability to claim the survivor benefit against their record.  In this case, the benefit paid will be equivalent to what the deceased spouse would have received if they had claimed their benefit on the day of their passing.

Inherited Retirement Accounts

A spouse as sole beneficiary is one of the exceptions of the ‘SECURE Act 10 Year Rule’ and allows the spouse to stretch the required minimum distributions (RMD) over the course of their lifetime.  A spouse beneficiary also has the ability to roll the account into their own IRA.

Generally speaking, there are two main factors that will drive the decision of which option makes sense:

  • Age – If you do not need the money now, you will want to lower the RMD as much as possible.  If you are younger than your spouse was, you will want to assume the IRA as your own but if they were younger you will want to leave the funds in the inherited IRA.
  • Need to Access – If you need to access funds now and are under the age of 59.5 you will want to leave the funds in the inherited IRA.  An inherited IRA is not subject to the 10% early withdrawal penalty but if you roll over the funds into your own IRA the funds will now be subject to early withdrawal rules.

Tax Planning

The biggest financial impact a surviving spouse will feel is typically in their tax situation.  When a spouse passes away, assuming the surviving spouse does not remarry, they will be subject to Single tax filer rates beginning the year after the death of the first spouse.  

Roth Conversions

Accelerating Roth conversions in the year of death can be a prudent tax move but proper tax planning is appropriate to determine the amount.  The surviving spouse will find themselves with the same sized RMD but now subject to Single filer tax brackets and with the possibility of the funds becoming subject to the 10 Year rule looming should they pass.

As shown in the comparison above, the Single filer tax brackets are significantly compressed compared to Married filing Jointly, therefore someone realizing roughly the same level of income can find themselves in a much higher tax bracket making Roth conversion more prudent the final year of filing at MFJ thresholds.

Example: Nigel’s wife Phoebe has passed and he expects to continue to realize $200,000 in taxable income next year and going forward.  This year, that would put Nigel in the 24% MFJ tax bracket.  Beginning next year, that same income would put Nigel in the 32% Single tax bracket.  Assuming he takes the Standard Deduction, Nigel can convert roughly $166,000 this year and stay in the 24% tax bracket.

Basis Step-Up

Whether you receive a full or partial step-up in basis is largely determined by whether you live in a community property state or not.  Community Property states (including Texas, California, Arizona among others) provide a 100% step-up in basis on community property taxable assets while non-community property states receive a 50% step-up in basis on taxable assets in the estate.

This can allow for the sale of highly appreciated securities that are no longer appropriate to hold to be sold for little to no tax impact.  Additionally, if there are sufficient assets in the taxable portion of the investment portfolio to cover living expenses this can help keep recognized income in the year low and maximize the amount that can be converted to Roth.

Primary Residence Capital Gains Exclusion

The Primary Residence Capital Gains exclusion allows homeowners to sell their home without paying capital gains taxes on the first $500,000 in gains if married or $250,000 in gains if single, assuming the owner has both lived in and owned the property for two of the live five years.  If the spouses have owned the family home for many years and it has significant appreciation, it may be prudent to consider selling if that is an eventual likelihood.

The surviving spouse can use the married exclusion of $500,000 if the home is sold within two years of the decedents passing.  This is often a difficult decision to make but if it is made within the allotted timeframe there can be substantial tax savings.

While there are many other considerations going on during this period, both financially and otherwise, our hope is that these planning ideas add value during a period where decision making can be difficult.  If you’d like to speak with our team to discuss how these strategies might apply to your situation, schedule a meeting with our team here.

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Disclosure: The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Expressions of opinion are as of this date and are subject to change without notice.  There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.  Raymond James Financial Services, Inc. and your Raymond James Financial Advisor do not solicit or offer residential mortgage products and are unable to accept any residential mortgage loan applications or to offer or negotiate terms of any such loan. You will be referred to a qualified Bank Consultant for your residential mortgage lending needs. 

Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion. 

While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

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