For most, retirement planning involves looking at the future for a two-person household. Many couples have a tough time talking about money. (See this blog for some help getting the conversation started.) While they may enjoy talking about retirement and the wonderful things they will do once they stop working, they don’t talk much about finances.
Unfortunately, we can’t avoid talking about finances. We don’t know what we can do in retirement unless we understand our full financial picture. We must make assumptions about spending, income, and insurance needs. We should set and prioritize our goals for what we want to do in retirement. There needs to be a plan for how our retirement savings will be withdrawn as well. A plan for how to withdraw funds from retirement accounts is also needed. Those discussions tend to focus on the couple rather than the surviving spouse as well.
Normally, one member of a couple outlives the other – sometimes by many years. At that point, retirement planning becomes a one-person story. Good planning considers this change in status before it happens. You want your retirement plan to help protect you from the “survivor trap.” It should contemplate the transition to widowhood for the surviving spouse.
Why Does This Matter?
Would it surprise you if I said it starts with taxes? Assets often pass first from one spouse to the other. That helps the surviving spouse maintain her lifestyle (sorry guys, your wife will probably outlive you). When she files her tax return, her filing status will change to single, rather than married filing jointly. But her income may not change all that much. She should expect her tax bill to increase. This phenomenon has also been called the “survivor trap” or the “widow’s penalty.”
How does this work? An example should help. Assume adjusted gross income (dividends, capital gains, retirement distributions, Social Security) equals $80,000. In 2021, those who file a joint tax return receive a standard deduction of $25,100. Joint filers who are 65 or older get an additional deduction of $2,600. For single filers, the standard deduction drops to $12,550. The additional deduction for those 65 and older is $1,700.
That leaves taxable income of $52,300 ($80,000 – ($25,100 + $2,600)). Your top tax rate would be 12%. Your tax bill would be $5,878.
What happens if your filing status changes to single, but your adjusted gross income doesn’t change? Your taxable income will increase to $65,750 ($80,000 – ($12,550 + $1,700). Your top tax rate would increase to 22%. Your tax bill increases to $10,214. Ouch!
What Else Can Happen?
The smaller of the couple’s two Social Security checks automatically disappears. For example, if one spouse was receiving $2,500 per month and the other was receiving $1,750 per month, the surviving spouse only gets $2,500. The other $1,750 disappears.
It goes even further. The surviving spouse now has more taxable income. That could mean more of her Social Security benefits are taxable. If your income is high enough, a surcharge on Medicare could also apply. (Note that this would not be the case in the above example.) If your income is high enough, you could also pay a surtax on net investment income. You might not have been subject to this tax before your spouse died, as the thresholds for these taxes are lower for single filers.
What Can You Do?
1. Make decisions jointly. When you create a financial plan, make sure both spouses have a say in the decision-making process.
2. Consider Roth Conversions. You can strategically convert some of your 401(k)s, 403(b)s, or traditional IRAs. A series of partial conversions often works best. This strategy can help keep you from creeping into a higher tax bracket. By converting to a Roth now, the surviving spouse won’t have to worry about paying taxes when she withdraws money from the account. She also won’t have to take required minimum distributions from her Roth account beginning at age 72. There’s another benefit, too. If any money is left in the account after the second spouse dies, your heirs won’t have to pay taxes on distributions either.
3. Understand how Social Security benefits work for married couples. You can use claiming strategies to maximize the amount the surviving spouse will receive.
4. Be careful about debt. Repaying debts (mortgages, credit cards, auto loans, etc.) before you retire can reduce financial stress during retirement. It can also make things much easier on a surviving spouse.
5. Review any employer pensions you may be entitled to. As with Social Security, you want to understand the payout options. Assess the various scenarios to help decide how each option would impact a surviving spouse.
6. Check your beneficiary designations. Make sure these are correct on any insurance policy or account that can be inherited. This can make it easier to transfer assets. Both spouses should know where important documents are stored. Both spouses’ names should also be on utility bills, titles, leases, etc., too.
7. Maintain a list of passwords and account numbers. Both spouses should have access to a secure list of passwords, online accounts, and digital property. You can keep this information in either an electronic file or a book with your account numbers and passwords. Without this, the surviving spouse may have trouble accessing accounts after the first spouse passes.
What if You Are Single?
When thinking about retirement, we often look at it from a couple’s perspective. Some people never marry. Others are widowed or divorced. Planning involves more than taking the advice for a couple and halving it. While the following recommendations apply to couples, too, they are even more important for singles.
1. Protect your income. Most employers offer disability insurance. If yours does, and you don’t have such coverage get it. If yours doesn’t, try to secure coverage privately. You only have your income to rely on. If something happens to you, you must make sure you still have some income coming in. Once you retire you can drop this coverage.
2. Build an emergency fund. This fund should cover three-to-six months of expenses. It should be a cash-type account and easily accessible. When deciding whether to be closer to three months or six, consider the safety and stability of your employer and your job.
3. Save for your future. Some singles tend to be more conservative with their asset mix. Be careful about being too conservative. It can limit the benefits that come with putting your money to work. (In general, we expect stocks to provide better returns than bonds or cash.) Make sure you have adequate exposure to equities – you want to try and decide the right mix for you. You don’t want a portfolio that makes you uncomfortable. You also want to try and minimize the impact that the emotions of fear and greed have on your portfolio. Fear can make you want to sell when markets are low and buy when markets are surging higher.
4. Protect your health. This goes beyond taking care of yourself, which can help keep your medical bills low. Make sure you have a medical power of attorney (MPOA) and a financial power of attorney (FPOA). Choose who you want to make decisions for you if you become incapacitated. For the MPOA, you must decide what kind of power you want your healthcare proxy to have. Normally, you want a “springing” power of attorney. This takes effect when you are declared incapacitated by two doctors. It will cover short- and long-term health issues. If you recover, the springing power is canceled. You also want your MPOA to include HIPAA waivers. Springing language should be included in the FPOA as well. If possible, you should choose someone who has some financial acumen for your FPOA. Your healthcare and financial proxies should have a copy of the MPOA and FPOA, too.
5. Advanced health care directives. When planning for future medical care, preparing advance directives goes a long way. It helps your loved ones make choices according to your wishes. You can find free advance directive forms for where you live here. While this can be a difficult topic to discuss, it can provide you with a sense of peace. It can also reduce anxiety for your friends and family. Having a plan in place can help.
6. Reduce debt. When it comes to debt, maintaining discipline matters. Don’t become too enticed by the low-interest-rate environment. If you have outstanding debt, put together a plan to repay it. This practice can help if you lose your job, or the economy falls into recession. When your income is lower, it helps to keep your monthly obligations lower. It allows for much more flexibility, too.
Whether you are single or married, putting together a financial plan should be a key element of any retirement planning you do. If you would like to discuss how to get started with your financial plan, please contact us for a free consultation.
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For firm disclosures, see here: https://apprisewealth.com/disclosures/
Phil Weiss founded Apprise Wealth Management. He started his financial services career in 1987 working as a tax professional for Deloitte & Touche. For the past 25+ years, he has worked extensively in the areas of financial planning and investment management. Phil is both a CFA charterholder and a CPA.
Located just north of Baltimore, Apprise works with clients face-to-face locally and can also work virtually regardless of location.
