The stress can be enormous when a spouse passes away. It’s generally a bad time to make financial decisions. You will want to avoid making major changes during that time, if you can. Let your…
The stress can be enormous when a spouse passes away. It’s generally a bad time to make financial decisions. You will want to avoid making major changes during that time, if you can. Let your emotions settle down a bit before making moves that could drastically affect your taxes and finances.
“Any decision they make, they should make sure they speak to a professional, a financial planner or a certified public accountant,” says Joe Edmondson, a financial professional with AXA Advisors in New York. Edmondson says people sometimes come to him for advice only after they realize they made a mistake that will cost them unnecessary taxes and possibly IRS penalties.
Take care to avoid these mistakes after the death of a spouse:
— Ignoring tax implications.
— Failing to plan for lower Social Security and annuity income.
— Taking unplanned withdrawals from tax-deferred accounts.
— Paying taxes on retirement account withdrawals too soon.
— Getting stuck paying a 10 percent early withdrawal penalty.
— Forgetting to take a required minimum distribution.
— Waiting to seek advice.
Read on to find out more about potential taxes and penalties after a loved one passes away.
Ignoring Tax Implications
Your tax-filing status will change after a spouse passes away, which could push you into a higher tax bracket or cause you to lose tax breaks. “What happens when your spouse passes away and you don’t realize is that you now are losing some benefits,” says Karen Mims, a tax attorney and founder of Harbour Pointe Wealth Management in Columbia, Maryland. “You can no longer file married filing jointly. If you no longer have two exemptions, the chances are that will hurt you (financially).”
Failing to Plan for Lower Social Security and Annuity Income
You may also lose your deceased partner’s Social Security income. While widows and widowers can claim a Social Security survivor’s payment equal to the amount the higher earning spouse received, there will now be one Social Security check coming into the household instead of two. In some cases, pension or annuity payments might also stop. “Be careful if people are receiving pensions and annuities — especially the life annuity, which pays while the purchaser is alive only, or 50 percent joint annuity, where the surviving spouse will receive only half of the original payment,” says David Levi, senior managing director of CBIZ MHM in Minneapolis. “There will be significant changes to income.”
Taking Unplanned Withdrawals From Tax-Deferred Accounts
Many people look to make up that lost income by taking retirement account withdrawals, but missteps can trigger both taxes and penalties. Income tax is due on each traditional 401(k) or IRA withdrawal. “When you take out tax-deferred money, there are tax consequences,” Mims says. When you make that withdrawal from a spouse’s IRA, the taxes are due. And, if you are not 59 1/2 or older, you could also pay a 10 percent early withdrawal penalty.
Surviving spouses should take care to minimize taxes on retirement account withdrawals to help the money last as long as possible. “People have to be careful before they start taking money out of retirement accounts,” Levi says. “There are lots of planning opportunities. If you start doing stuff without thinking about it, you may miss some opportunities.”
Paying Taxes on Retirement Account Withdrawals Too Soon
A surviving spouse can transfer tax-deferred retirement account assets into his or her name, which often allows you to further delay taxation. “If you are under 70 1/2, it gives you the ability to defer taxes into the future,” Edmondson says.
Getting Stuck Paying a 10 Percent Early Withdrawal Penalty
If the surviving spouse is younger than age 59 1/2 and needs access to some of the funds in a retirement account, you can transfer the money into an inherited spousal IRA. “If you need money, the IRS will allow you to take distributions,” Edmondson says. “You will have to pay taxes, but you avoid that 10 percent penalty the IRS could charge.”
Forgetting to Take a Required Minimum Distribution
Distributions from retirement accounts are required after age 70 1/2, even in the year someone passes away. “If the decedent was in payout mode and past 70 1/2, make sure between decedent and beneficiary you still take the required minimum distribution,” Levi says. “We’ve had situations when people passed, and nobody remembers. You can have a potential penalty of up to 50 percent of what you should take. (It) could be expensive.”
It isn’t always easy or realistic to focus on your finances shortly after losing a loved one. The best course of actions is often to avoid making any big money moves without advice. “They should incorporate tax planning, especially when they are doing estate planning,” Mims says. “They should incorporate a tax advisor to help them with what happens now.”