The emotional toll of losing a spouse is immense, and for many, the financial burden only adds to the grief. A phenomenon known as the "survivor trap" can leave surviving spouses facing higher tax bills, further compounding their hardship.
The survivor trap arises when a single tax filing status results in a higher tax bracket or eliminates tax breaks previously available to a married couple. This often coincides with the retirement years, when required minimum distributions (RMDs) from retirement accounts become mandatory. These mandatory withdrawals can trigger a larger tax liability for the surviving spouse.
While completely avoiding taxes is not realistic, financial planning and strategic measures can help mitigate the impact of the survivor trap. Here are six key strategies:
1. Diversifying
Investments:
Financial advisors recommend positioning assets before retirement to increase flexibility and minimize tax hits. This involves holding investments in taxable accounts that are not subject to RMDs. Using these for income allows you to manage tax consequences through strategies like selling stocks with a stepped-up basis (eliminating capital gains) or converting traditional IRAs to Roth IRAs (paying taxes upfront to avoid RMDs).
2. Charitable Giving:
Maximizing charitable contributions can increase itemized deductions, potentially lowering your tax burden. Consider qualified charitable distributions (QCDs), allowing you to donate up to $100,000 directly from your IRA tax-free. Remember, specific rules apply to QCDs, and you cannot claim the contribution as an itemized deduction.
3. Strategic Gifting:
Gifting income-producing assets to children or grandchildren in lower tax brackets can reduce your estate and lower the surviving spouse's tax bill. This can be done outright or through trusts. Remember, while exceeding the $18,000 annual gift tax filing limit only requires reporting, exceeding the lifetime exclusion limit of $13.61 million can incur taxes.
4. Capital Loss
Harvesting:
Investors with capital gains can utilize capital loss harvesting to offset those gains and potentially reduce overall taxable income. This involves selling assets at a loss to counter gains from other investments. Unused capital losses can be carried forward indefinitely to offset future income.
5. Spousal Rollover
IRA:
For surviving spouses with a significant age difference from their deceased partner, a spousal rollover IRA can be beneficial. This allows the surviving spouse to inherit the deceased's IRA and delay RMDs based on their own age, potentially reducing taxable income. This strategy also allows for continued contributions, further increasing tax-deferred growth.
6. Relocation (with
Caution):
For some, selling the family home and relocating to a state with lower income taxes might be an option. However, strict residency requirements make it crucial to demonstrate a legitimate move and avoid triggering tax audits. Consult with a professional to understand the implications before considering this approach.
Navigating the complexities of the survivor trap can be overwhelming. By proactively implementing these strategies and consulting with a qualified financial advisor, surviving spouses can take informed steps to mitigate the financial burden and navigate this challenging period with greater financial security.
