Surviving spouses shouldn’t make any major financial changes immediately but should reassess their finances from a tax perspective.
Yahoo Finance’s recent article entitled “The Financial Effects of Losing a Spouse” explains that the loss of income after a spouse dies has tax implications. For example, if a decrease in income means the surviving spouse is required to use funds from a retirement account, taxes may be less than initially thought because, if you have lower income, you may be in a lower bracket. Less income could also mean qualifying for certain tax deductions or credits that have income limits or phase-out rules. There may be local income-based property tax breaks that may also become available.
A surviving spouse will have a new filing status. A joint federal tax return is allowed for the year the deceased spouse dies, if the survivor did not remarry. The qualifying spouse status may be an option for two more years, if there is a dependent child. After that, the survivor who does not remarry is required to file as a single taxpayer, which usually means less favorable tax rates and a lower standard deduction.
Inheriting a traditional IRA can also impact the surviving spouse’s taxes, but first, an inheriting spouse can be designated as the account owner. If so, he or she can roll the funds into their own retirement account or be treated as a beneficiary. That decision will affect required minimum distributions (RMDs) and ultimately the surviving spouse’s taxable income. As either the designated owner of the original account or the owner of the account with rolled-over funds, the surviving spouse can take RMDs based on their own life expectancy.
If the third option of remaining the IRA’s beneficiary is selected, the RMDs are based on the life expectancy of the deceased individual. Most people either roll an inherited IRA into their own IRA or at least they transfer it into an account in their name. Consolidating makes things much easier to manage. The third option may be wise if the surviving spouse is at least 72, but the deceased was not. In that case, the RMDs from the inherited IRA are delayed until the deceased would have turned 72.
A surviving spouse also gets a stepped-up basis in other inherited property, if the assets are held jointly. It is a step up in one half of the basis. However, if an asset was owned solely by the decedent, the step up is 100%. In community property states, the total fair market value of property (including the part belonging to the surviving spouse) becomes the basis for the entire property if at least 50% of its value is included in the deceased spouse’s gross estate.
As far as estate taxes, there is an unlimited marital deduction as well as this year’s $11.7 million estate tax exemption. If the deceased spouse’s estate does not reach that, the survivor should still file Form 706 to elect “portability” of the deceased spouse’s unused exemption amount.
Learn more about estate planning for retirement here. If you need assistance with elder law or estate planning matters, please contact The Stegall Law Firm at (713) 568-6514.
Reference: Yahoo Finance (July 16, 2021) “The Financial Effects of Losing a Spouse”