While the role of careful retirement planning is to make later years as stress-free as possible. Most retirement advice that is geared toward married couples doesn’t always give much attention to a surviving spouse’s inherited IRA. Bill Harris, co-founder at WH Cornerstone Investments in Duxbury, Mass., shares some insights.
Larry Light: How do you recommend that couples start with planning ahead for retirement and life beyond?
Bill Harris: One of you will live a few—or many—years without the other. That’s where estate planning comes in and what we call giving the gift of preparedness. It’s about making the most of the resources that have been accumulated over time. And estate planning is much more than just having wills and other instruments in place.
It’s also about how those accumulated resources will support the surviving spouse for as long as needed. Do an online search for investment strategies, tax minimization or portfolio risk management, just for starters, and you’ll be overwhelmed by all the helpful suggestions. But trying to sort the advice out without the help of a professional can be precarious because so many factors are at play all at one time: inflation, market volatility and tax code changes, among others.
Light: Yet curiously one area that receives very little attention is that of a surviving spouse’s inherited IRA?
Harris: Yes, that’s surprising. The IRA is one of the most common assets a couple will have in their portfolio. About $25 trillion is held in retirement assets in the U.S., so inheriting a deceased spouse’s IRA touches almost everyone. Mishandling a spousal IRA can do significant damage to the survivor’s finances.
Light: Can you explain the options available when inheriting a spousal IRA?
Harris: There are special benefits for sole spousal beneficiaries. Widows who are the sole beneficiary of their husband’s IRAs enjoy special tax treatment if they are set up correctly. As the widow, there are options of how to receive the IRA, including establishing an inherited IRA, doing a spousal rollover or doing nothing.
Light: What are the pitfalls to be aware of?
Harris: Unfortunately, widows also face traps and hurdles that can wipe out significant portions of their inheritances. While the first year of widowhood might be the hardest emotionally, the second year is when the IRS’s regulations have the most significant financial impact. When a couple got married, as newlyweds, they were penalized when they first filed as married jointly. They paid more income tax together than as two single individuals would with the same total income.
This is called the “marriage penalty.” As a widow, for the year of the spouse’s death, the IRS allows a widow to file as married filing jointly. But in the second year, the “widow’s penalty” kicks in. The widow will lose the higher standard deduction of being part of a couple, so their taxable income may be higher than before. They will also be taxed at the rates on the tax tables for singles, where next-tax-bracket thresholds occur at much lower dollar values.
Light: So, the significance is now in being treated as an individual rather than as part of a couple. Are there other tax implications?
Harris: Yes, other obligations have lower thresholds, too, and may raise the tax burden. For example, the “Social Security Tax Torpedo” can throw you into higher percentages of your Social Security income being taxable. While the surtax on net investment income is triggered on lower levels of modified adjusted gross income when you’re single. Don’t forget Medicare IRMAA, meaning Medicare’s income-related monthly adjustment amount, may apply to your monthly premiums for Medicare Part B, which is medical insurance, and Medicare Part D, for prescription drug coverage, where it didn’t when you were in a couple because the singles thresholds are lower.
Light: Do you have any final thoughts to share?
Harris: The number of tax disadvantages and advantages of widowhood may appear overwhelming but, again, not if described in everyday language and with ample examples. Widowhood is a time for grieving. For honoring. For getting your feet back on the ground. It’s no time to worry about missing critical deadlines or making financial mistakes that can derail your post-widowhood plan.
The scary part is that many decisions cannot be reversed. In my book, Inheriting Your Spouse’s IRA (The Widows Guide to Keeping More of Her Assets), a couple can use the planning guide to be sure that their retirement and estate plans are rock-solid for whichever spouse becomes the survivor.