Death is a harsh reality of life. It’s the worst part of my line of work. Unfortunately, since I’ve been doing this for a long time, I’ve had a number of clients who became good friends pass away. It’s awful. It’s hard. And it’s unavoidable. The least we can do is help make that transition as smooth as possible for the loved ones left behind. When someone dies, he or she likely leaves somebody behind, and that somebody still has financial needs. That person is my client’s reason for working with me. They need to put a strategy together that will ensure their loved one is cared for after he or she is gone. Because, unfortunately, the loss of a loved one can affect your financial circumstances. So, we focus on strategies that prepare for the “Survivor’s Trap” or the “Widow’s Penalty.”
What is the Widow’s Penalty?
The widow, or widower’s, penalty is a term referring to the negative financial impact death has on the surviving spouse. Things like changes to your filing status and the reduction of your social security benefits all affect your financial circumstances.
These are pitfalls that, with some forethought, you can manage. Our approach is to consider what happens “when” rather than “what if” these penalties hit and nail down how much money clients will lose when one of them passes. It’s not limited to what you would think.
Here are the 5 areas of the widow’s penalty to consider when developing your retirement strategy.
1. The Widow’s Penalty & Social Security Benefits
Under the current social security rules, if one person passes away, the survivor will generally receive the larger of the two benefits (I say generally because different rules apply if you have a federally funded pension). Let’s say, for example, with a couple the wife receives $2,100 monthly in social security and the husband receives $1,700. Regardless of who passes away, the survivor will get $2,100 monthly in social security. Now, while $2,100 is the larger benefit, the difficulty is they’d need to strategize for the $1,700 reduction of their monthly income. Suddenly his or her income is cut from $4,800 to $2,100. This reduction will likely have a serious financial impact on the survivor, so they need to plan ahead with regards to how they take social security and when they should take it.
We often counsel clients on the timing of when they take social security benefits. The benefits of waiting are obvious, but there’s also a negative. It’s called the “break-even” age.
What’s your “break-even” age?
The term “break-even” essentially means how long it will take you to make up the difference in the money if you postpone taking Social Security in order to get a larger amount in monthly benefits. When you opt to take social security benefits early you make the permanent choice of reducing your benefits for the rest of your life, not just until you reach “full retirement age.”
If you decide to delay for the larger monthly benefit, you have to give up the reduced amount for a period of time. For example, say you decide not to take Social Security at 66 when you’d receive $1,500 a month and instead take it at 70 for $2,000 a month. While you would get an extra $500 bucks a month, you would have to give up $1,500 a month for years. which would take approximately 7 to 11 years to break-even.
2. The Widow’s Penalty & Probate
Another important factor when a person dies is the issue of probate. Probate is the process when the court accepts a will as a public document. The probate court reviews the deceased’s assets and provides a final ruling on how to distribute the assets among the beneficiaries. If you don’t have all the necessary paperwork in place, assets can be stuck in probate for years. It’s called dying intestate, and it’s often a real problem.
Many years ago, I started working with a newly retired schoolteacher down on the Cape. We’d just start working together – didn’t even get to the point of implementing anything. Anyway, two weeks into his retirement, his wife goes into the basement where he was working on his computer and finds him. He’d had a massive heart attack and passed away. Horrible right? Two weeks into his retirement planning. Just filed for his pension and his whole retired life ahead of him. Completely tragic.
Now, normally people think when the husband passes away everything just transfers to the wife. For the most part, that’s correct. But there was a glitch in this case.
In addition to teaching, this guy had a side business fixing computers. His side business did quite well, and he had managed to put $110,000 cash in a separate business bank account, but he’d opened it in his name only. Unfortunately, we hadn’t had time to develop their strategy, so there weren’t any legal documents. His wife couldn’t touch the account for two years. Two years delay just because a simple document wasn’t in place.
Do some Survivor Planning
Unfortunately, I’ve been involved in many stories like this over the years. Problems that retirees could have easily avoided if somebody had their legal house in order. Creating an estate plan is critical, which is why we recommend working with an attorney and mapping out your plans for after you’re gone. We call this Survivor Planning. It can save you, your family, and the people you leave behind a whole lot of heartache. Get the documents like a will, power of attorney, health care proxies, revocable trusts, etc. in order now. You’ll save yourself from any worry and you’ll save them potentially years of distress.
3. The Widow’s Penalty & Tax Filings
The next area impacted is taxes. When a married couple files jointly and one of them passes away, the survivor suddenly becomes a single-filer.
So, hypothetically, if you’re a joint-filers and have $80,000 worth of income, you’re in (roughly) the 12% tax bracket. But if one of the spouses passes away, the survivor becomes a single-filer with the same income, moving them from the 12% tax bracket to the 22%. Same income, the same lifestyle, basically the same bills. But now things cost a lot more because Uncle Sam bumped him or her up.
You can avoid this sort of tax trap by being proactive in how you pay your taxes. One of the strategies we implement, if it makes sense for a client, is a Roth conversion. It’s basically paying some taxes on pre-tax money now. For example, taking 401ks and IRAs and transitioning them to Roth IRAs where they grow tax-free and distributions can come out tax-free at any point down the road. Why would that be important to survivors? Just look at our example. If they both have Roth IRAs, they could avoid the bump from the 12% to a 22% tax bracket.
4. The Widow’s Penalty & Pension
Pensions are another area where we help clients manage the widow’s penalty. It’s a very varied world. There are private, public, and federal pensions and then there are more options inside of pensions. How you choose is based on your particular situation but examples of things to consider are:
Do you want to take a single payout that pays the maximum amount to the person who works for the pension, with no survivor benefit for the spouse? Most people would say, “No! Why would I want to do that? That would leave them with nothing!” But what if your spouse worked in social security and has their own social security benefit? If they die, you’re not going to get any of their survivor benefit, so maybe you do want to get a bigger benefit.
Maybe you want to pursue buying life insurance to protect against the loss of income from either side of that equation.
Maybe you’re not in great health going into retirement, and it doesn’t make sense to take a single only benefit.
As you can see there are many options to consider when it comes to pensions. Truthfully, your best bet, in this case, is to consult a qualified professional who can help you think through how you want your pension to work for you.
5. The Widow’s Penalty & Life Planning
Avoiding the widow’s penalty extends beyond the traditional financial considerations. Unfortunately, you have to plan for life when you’re on your own. Again, it’s a difficult prospect, but you want to make the transition as seamless as possible. Do things as basic as…
Review your beneficiary designations
Regularly check who you named on all of your investment and life insurance policies and anything that has a beneficiary. Make sure that you’ve named the person you want to inherit that asset. So often I’ve seen clients who had listed beneficiaries on their forms and then they forget. One of my clients had been divorced for 20+ years, but her ex was still beneficiary on a couple of her smaller accounts!
Name contingent beneficiaries
A contingent beneficiary is like a backup beneficiary. This helps you avoid instances where you pass away and your beneficiary passes away without naming beneficiaries. If your beneficiary passes away and you have no contingent beneficiary, everything is paid to your estate. This creates probate. Creates taxes unnecessarily. So, name contingents!
Put your legal house in order
Legal documents are critically important. Have your legal house in order to ensure that there are people who can act as backup power of attorney and Health Care Proxies for you if your spouse is no longer with you.
Identify additional assets
These aren’t cash or financial assets, but property assets. You share a home for fifty years with your spouse. Your spouse passes. And then you’ve got the issue of that huge asset. Whose name is it in? Who’s seated to it?
My #1 Life Planning Tip: COMMUNICATION
The #1 recommendation I can make is for spouses to talk to each other. Talk to each other about money. Ensure you both understand where money is coming from. Point out where the go-to box with all the passwords in it is. Write it down somewhere so whoever is left behind has an easier time dealing with the aftermath.
Consider your team
Who’s involved? Who does your loved one need to talk to when, God forbid, something happens? Do you have an investment person, an insurance person, an attorney, an accountant, etc.? Your loved one needs to contact everyone on your financial team.
Death is the reality of life. At some point, we will all depart this life. If you die and your spouse lives for another 15, 20, 25 years, you want to make sure that they’re financially covered. If you anticipate and prepare for the widow’s penalty, it doesn’t have to be something you worry about. The sooner you start considering this the better. It’s never too early. You could make money. You can lose money. They’re just things. But you can’t get the time back. So, let’s not waste a second more of it worrying about if we have the right safeguards in place.
Rowlette and Associates, LLC DBA: South Shore Retirement Services – an affiliated company – is an independent financial services firm offering both insurance and investment services. Investment advisory services are offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Rowlette and Associates, LLC DBA: South Shore Retirement Services not affiliated companies. Investing involves risk, including the potential loss of principal. Any references to protection benefits, safety, security, lifetime income, generally refer to fixed insurance products, never securities or investment products. Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Our firm is not affiliated with or endorsed by the U.S. Government or any governmental agency. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. 1235726 – 03/22
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