The Widow’s Penalty Part 2: IRA Choices, RMD Deadlines, IRMAA Traps, and the “Year-of-Death” Roth Window

Protecting and Preserving Wealth Episode 85 – The Widows Penalty Part 2

Speakers: Bruce Hosler, & Alex Koury, Jon Gay

Jon Gay (00:04):

Welcome back to Protecting and Preserving Wealth, I am Jon Jag Gay. I’m joined as always by Bruce Hosler and Alex Koury today.

Now, in our previous episode, we talked about the widow’s penalty. We went through some mechanics of that, so I would encourage you to go back and listen to that episode if you have not done so before listening to this episode. We’re going to dive a little bit deeper today.

Hello, Bruce and Alex.

Bruce Hosler (00:24):

Hello, Jon. Good morning.

Alex Koury (00:26):

Good morning, Jon.

Jon Gay (00:27):

Okay, so let’s dive right in here. How can a surviving spouse’s tax liability increase? It’s probably a good spot to pick up from where we left off last time.

Bruce Hosler (00:37):

We know that most of our clients, while they’re married, they get a file married filing joint, and I’m going to pick on the guys because the guys die first, the women last longer. So, this is a widow’s situation. Her husband dies, how does her liability go up?

Well, the tax liability per se doesn’t go up. But what happens is, number one is, she goes from married filing joint- which has a favorable tax bracket for a married couple- to single, and the limits on income are very punitive. In fact, they’re like half. And so, if she has required minimum distributions, social security income, things like that, she goes into a much higher tax bracket just immediately on that.

What about the lost deduction? Now, most of our clients, when their husband dies, Alex, these widows, we have the new One, Big, Beautiful Bill. What is the tax deduction that all of these 65-year-old seniors get?

Alex Koury (01:44):

Yeah, so the one everyone was excited about is that senior deduction. When that spouse passes away, the surviving spouse is going to lose that deduction as well.

Bruce Hosler (01:51):

So, she loses that $6,000 deduction, and even if she’s taken a standard deduction, now she only has hers, and so he’s going into a higher tax bracket for the years following his date of death. The year that he dies, she can still file married filing joint, and we’re going to talk about that later of what the tax moves is that she should do.

But she needs to know that now she’s been penalized and she’s been put in a box, and they’re going to penalize her filing … even though she was a true spouse her whole life, she’s no longer married filing joint and she’s now filing single, and that’s not going to be very friendly.

Jon Gay (02:32):

I’m glad we’re talking about this today, Bruce, because you think about someone losing a spouse, in this case a husband, it’s a traumatic thing. There’s so many emotions that go into it, and there’s also so many logistics that go into it. I’d imagine thinking about the fact that next year, you have to file single is not really the top of people’s lists, so I’m glad we’re covering it today.

Bruce Hosler (02:51):

Right, and it’s not just next year, but it’s the rest of her life. So, it changes all the sources of income and what you do and what brackets she goes into and how they’re taxed. Now, because we’re IRA experts, Ed Slott, Master Lead IRA advisor, I worry about this stuff. Let’s say that he died after his RBD (Required Beginning Date).

So, if you’re born before 1960, you have to take required minimum distributions at age 73. If you’re born in 1960 or later, you don’t have to take your required minimum distribution until you’re age 75. But let’s say he died, he did not take the RMD yet. What’s the deadline for him taking that RMD that year, Alex?

Alex Koury (03:40):

So, you’ve got to get it out by December 31st of that year to satisfy the RMD for tax purposes.

Bruce Hosler (03:47):

Yes. And then there’s a penalty if she doesn’t take it out. Now, they’ve introduced a new rule that allows an automatic waiver of the penalty. If she gets it out by the following year, by the end of the year, she has to get it out, she can avoid the penalty, but she needs to take that.

Now, if she forgets to take it that year, what happens? She has to double up the next year potentially, depending on the next topic that we’re going to talk about. But if he dies in January, February, that makes it easy. But what if he dies in November or December? She’s probably not thinking, “Oh, I got to get the RMD out, I haven’t taken it yet.”

Jon Gay (04:27):

Same idea, not top of mind. She’s got too much else she’s dealing with.

Alex Koury (04:30):

She’s grieving everything else.

Bruce Hosler (04:32):

It’s terrible. So, one of the things we do with our clients is we’re doing Roth conversions every year. We encourage our clients that are old enough with a required minimum distribution, “Hey, let’s take that out in January or February. Let’s get that RMD out of the way.” If she’s been working with us and her husband already got the RMD out of the way, she’s home free. She’s already got it taken care of.

Jon Gay (04:53):

Okay, so let’s zoom out a little bit, guys. What options does this surviving spouse have?

Bruce Hosler (05:00):

Great question. So, Alex, why don’t you start with option number one, the spousal rollover?

Alex Koury (05:06):

Absolutely. So, when you’re the primary beneficiary, you’re the spousal beneficiary there, you have the option to roll over that IRA into your own IRA account. So, you can combine, essentially, the money that you had for your retirement accounts with your husband’s. That’s option number one, spousal rollover.

Bruce Hosler (05:23):

So, then the second one is: treat the IRA as the spouse’s own. So, how does she do that? He has an IRA. Let’s say it’s at Fidelity; how does she treat that as her own? Alex?

Alex Koury (05:36):

Well, she could have it titled in her own name, that’s the second option. You can keep it separate if you’d like to in different account, but under your own name as well, since now you are the new legal owner of those assets.

Bruce Hosler (05:50):

Now, the third one I want to talk about is very important for our younger widows because if a widow is over 59 and a half, she’s not subject to a 10% early withdrawal penalty, but let’s say she’s pre-59 and a half, we don’t want her to roll that into her own name. We don’t want her to take that over as her own account because in either one of those situations, it’s her tax ID number on the account and the distribution reports to her subject to a 10% early withdrawal penalty.

So, if she will leave it in his name and she remains just a beneficiary of the account, now when she takes a distribution out of that IRA account as a beneficiary, it’s code four, which is a death code on the 1099R, and it’s not subject to a 10% penalty. So, she can take all that IRA money out that she needs to and avoid a 10% penalty all together.

When she becomes 59 and a half, hey, okay, at that moment, roll it over into your own name ladies and take control of that account as your own, but you can leave it in his name and remain a beneficiary as an inherited IRA. And that’s how you beat the 10% penalty if your husband dies before you’re 59 and a half.

Jon Gay (07:08):

That’s a really great point. And I really want to put a finer point in that because I want to make sure I understand this correctly. So, if the widow transfers everything over to her name and she’s not 59 and a half, she’s going to be subject to that 10% penalty.

Bruce Hosler (07:21):

Yes.

Jon Gay (07:22):

But if she leaves it in her deceased husband’s name and takes it out as the beneficiary of his IRA, she’s able to avoid that penalty.

Bruce Hosler (07:29):

Yes. And really, the technicality of that, Jon, is we’re setting up an inherited IRA account. So, she doesn’t leave it in his name. She sets up an inherited IRA account, and she remains a beneficiary of an inherited IRA account.

So, ladies, you need to have a financial advisor that understands these rules and talks to you about setting up an inherited IRA account and you’re remaining the beneficiary. That’s how you avoid that 10% early withdrawal penalty.

Jon Gay (07:55):

And this actually segues into our next point, gentlemen, which is: surviving spouse as a successor beneficiary.

Alex Koury (08:02):

So, this is in the example of inherited IRAs. So, let’s say that your husband had inherited an IRA from his or her mother or father, and based on the timing of that, he has to take out a required minimum distribution to continue depleting those monies because he’s a non-designated beneficiary since he’s a non-spouse.

But in this case, let’s say he dies, he has an inherited IRA, now, you are the successor beneficiary of that inherited IRA. You will still as well be required to continue making RMDs based on his schedule.

Bruce Hosler (08:42):

So, the required minimum distributions are not based on her age then, are they, Alex?

Alex Koury (08:47):

No, they’re not. They’re based on either the old rules, if the money was inherited pre-2019 where the husband can take out RMDs based on his life expectancy. But if it’s post-2019 and 2020 and beyond, now there’s a 10-year rule that applies to IRA accounts and the money has to be taken out by that 10th year. So, you need to continue that and be aware of those nuances.

Bruce Hosler (09:10):

But what I’m getting at is the RMD amount is based on his life, not hers, and she has to continue that same schedule up to the end of the 10 years, and then get it all out. Alex, do we really want her to leave that account growing until the 10th year and then pull it all out as one big taxable event in the 10th year? Is that our advice?

Alex Koury (09:30):

It’s not because then you’ve got growing assets, you’re accruing more money over there. So, when that money has to be taken out as a lump sum, potentially, the tax hit’s going to be a lot larger than what you would anticipate as well. So, take a little bit out every year to minimize your tax liability every year before year 10.

Bruce Hosler (09:49):

So, depending on her tax situation, we would create a tax plan and advise her probably at a minimum, Jon, to take 10% a year of that out. So, an RMD is a required minimum distribution, it’s not a maximum. She could clean out the whole account, or she could take it out over five years, or she could take 10% a year over 10 years. Or if her husband was already an inherited beneficiary for five years, she’s only got five years left, she may be wanting to take 20% out a year to get it out by that last 10th year.

Jon Gay (10:22):

Again, every situation is different. This is why you want to talk to a qualified professional for the best advice for your given situation. We alluded to this in our first part of this podcast, the previous episode, the widow’s penalty, talking about IRMAA surcharges and tax brackets. This is something that can really sneak up on you, right guys?

Bruce Hosler (10:38):

Oh, it is one of the things that clients complain about the most, is if they become subject to IRMAA penalties. And here’s the problem: as a widow, if she’s single, even though she may have required minimum distributions and social security benefits and a pension and other rental income or whatever like that, if it goes above $109,000 in 2026, she’s going to be subject to IRMAA.

And IRMAA is income related monthly adjustment amount. And what they do is an extra tax. They’re taxing your Medicare benefits, and you have to pay a penalty. So, the first one is $81 for part B and $1,450 on part D for the drug plan. And that happens all the calendar year long.

Except, here’s the thing, Jon: it’s not that your income went up the year that your husband died, that IRMAA doesn’t catch up for you until two years. So, it’s a two-year delay. So, in 2026, IRMAA IRS is looking at 2024 right now to determine who’s subject to the penalty.

And here’s the worst thing that really upsets people, is they’re getting their social security, they’re receiving their social security, and all of a sudden, their social security went down by a hundred dollars or $200, and they’re like, what happened?

And then they found out they had an IRMAA penalty, and they’re taking it out of their social security benefits, and that really upsets people.

Jon Gay (12:08):

And you mentioned Medicare and Social Security- they can hit you on both, right?

Bruce Hosler (12:12):

No, no. They take it out of your social security, but the penalty is based on your Medicare premium and the penalty that you have. And so, what they do is they withhold your Medicare premiums out of your social security benefit because they of course, want to get that premium. So they withhold it and you don’t even get to touch it.

Jon Gay (12:30):

I’m glad you cleared that up. Thank you. Let’s talk about Roth conversions before we wrap up. I know this is an important point as well.

Bruce Hosler (12:37):

So, we had a client last year, her husband died, they’d been married for many years. What did we advise her to do before the end of the year?

Alex Koury (12:48):

So, we actually advised her, again, to take advantage of those higher deductions to make a very large IRA to Roth IRA conversion. So, we converted the whole account- about $350,000 or so in that year.

Bruce Hosler (13:02):

Well, we’re forcing her taxes to go higher. Alex, is that really smart to do to force her into a higher tax bracket the last year, the year her husband died?

Alex Koury (13:11):

From a strategical perspective, yes it does. Because again, from that point going forward, yes, you take a little bit of a hit upfront, but going forward now, there’s going to be no more IRA distributions that go against your standard deduction; they’re going to be zero. So, now, you just created a tax-free stream of income that you can use in the future for your other needs.

Jon Gay (13:30):

Am I understanding this right? That if you were to do it in the year that the husband passed, you’re also based on the tax bracket on married filing joint as opposed to single, right?

Bruce Hosler (13:38):

That’s the key point, Jon, is it’s married filing joint, even though he died in February or April or March or whatever, the rest of that year, her income is married filing joint. She can do all kinds of things married filing joint that year. And one of them should be a big honking Roth conversion, perhaps converting the whole thing because every year after that, she’s going to be filing single.

Jon Gay (14:04):

Those single tax brackets.

Bruce Hosler (14:06):

Yeah. She’s not going to have near the tax bracket and the protection of that tax rate on that conversion.

Jon Gay (14:12):

Big honking conversion, that is a financial term, right?

Bruce Hosler (14:15):

Yes, it is. It’s scientific. Big honking conversion.

[Laughter]

Jon Gay (14:19):

I’ve said this a couple times, but I think it bears repeating. There is so much going on when you lose a spouse: emotionally, financially, logistically. It is very easy to not know about any of these things. Or even if you do know, you might forget because you’ve got so much on your plate. That is why you really need the help of a professional, and that’s why we’re here to provide this advice to you as well.

Bruce, Alex, if our listeners or viewers want to reach out to you and the team at Hosler Wealth Management about this or anything related to their finances, how do they best do it?

Bruce Hosler (14:50):

Well, Alex, how do they call you in Scottsdale?

Alex Koury (14:53):

So, give us a call at (480)-994-7342.

Jon Gay (14:58):

And if you want to reach us on the web, folks, we have a great website. We’ve got videos on there, hoslerwm.com. We’d love to have you reach out through the website. You can request an appointment, we can see you, or if you want to get to us in Prescott, you can reach us at (928)-778-7666.

Jon Gay (15:18):

Good stuff, gentlemen. I’ll talk again in a couple of weeks.

Bruce Hosler (15:20):

Thanks, Jon.

Bruce Hosler (15:21):

Talk to you soon, Jon.

[Music playing]

Disclosure: (12:56):

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