How Will the Widow's Penalty Affect your Railroad Retirement?

Greetings to all tuning in to the latest installment of the Highball Advisors Railroad Retirement whiteboard series. I'm John McNamara, representing HighBall Advisors, and today we delve into a topic that might not be the most pleasant but is crucially important for effective preparation. This subject dovetails with the broader realm of estate planning, and within it lies a significant aspect of tax planning known as the "widow penalty." While the term might sound alarming, it's an issue we need to address in order to navigate its potential impacts. Join me as we delve into this intricacy and explore how it can affect you and your financial future.

To offer a succinct definition, the widow penalty refers to the circumstance where the surviving spouse faces increased taxes on a reduced income following the loss of their partner. To break it down further, consider a couple who, while both alive, filed their taxes jointly under the "married filing jointly" status (MFJ). In the year of the spouse's passing, the filing status remains the same, but the following year, the surviving spouse switches to the "single" filing status. This transition carries substantial financial implications, hence the term "widow penalty."

To illustrate this concept, let's consider tax brackets for the year 2023. Currently, the 12% tax bracket for MFJ couples ranges from $20,208 to $89,000, while for singles, it's a narrower $11,000 to $44,000. The pivotal juncture lies beyond $44,000, where the tax rate escalates to 22%. This leap from 11% to 22% is a critical juncture that underpins the widow penalty.

Permit me to elucidate this with an example. Suppose a retired couple boasts a modified adjusted gross income of $85,000, falling within the 12% bracket for MFJ couples. However, after the passing of one spouse, the surviving widow's modified adjusted gross income stands at $72,000, considering adjustments in their retirement income. This change in income also means a shift in tax brackets, propelling the surviving spouse from the 12% bracket into the higher 22% bracket. This is the essence of the widow penalty, and it showcases the marked impact of shifting from the joint filing status to the single status.

But how can we navigate and mitigate this situation? Let's explore potential strategies that can help ease the tax burden and better prepare for such scenarios. Firstly, in the year of the spouse's passing, consider seizing the opportunity to execute Roth conversions, especially within the confines of the MFJ tax bracket. This can represent a strategic move to optimize your financial position while still enjoying the benefits of the joint filing status. To engage in this conversation and execute such strategies, proactive planning before such events is crucial.

Moving forward, maintaining a proactive stance is key. Continuously explore Roth conversions in lower tax brackets as part of your tax planning. Remember, the aim is twofold: not only to strategically manage taxes but also to mitigate the impact of the widow penalty. The more you can channel assets into Roth accounts, the lower your required minimum distributions (RMDs) will be when they become applicable. This proactive approach helps cushion the financial blow that could result from the widow penalty.

As part of my comprehensive approach to retirement planning, I assist clients in precisely these kinds of scenarios. Whether you're approaching retirement or already there, my Boarding for Railroad Retirement process offers tailored insights and strategies to navigate these complex financial landscapes.

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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. Highball Advisors encourages you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Highball Advisors, and all rights are reserved from Highball Advisors, and all rights are reserved.