There is no doubt that the stress can be all-consuming, when a spouse passes away. It's not a good time to make financial decisions. You should also avoid making any major changes for at least a year, if you’re able. Allow your emotions to settle, prior to doing anything that could drastically impact your taxes and finances.
U.S. News & World Report recently published an article, “Don't Make These Mistakes When Your Spouse Passes Away,” that warns us to take care to avoid these mistakes after the death of a spouse:
Taxes. Your tax-filing status will change after a spouse passes away. That could move you into a higher tax bracket or cause you to lose tax breaks. You can’t file married filing jointly and no longer have two exemptions.
Social Security and Annuity Income. You may also lose your deceased partner's Social Security income. Widows and widowers can claim a Social Security survivor's payment that’s equal to the amount the higher earning spouse received. However, there will now be just one Social Security check coming in, not two. In some instances, pension or annuity payments might also cease. You may see significant changes to income.
Unplanned Withdrawals from Tax-Deferred Accounts. Many people seek to make up lost income, by taking retirement account withdrawals. However, a mistake can trigger both taxes and penalties. Income tax is due on each traditional 401(k) or IRA withdrawal, because when you withdraw tax-deferred money, there are tax consequences. When you make a withdrawal from a spouse's IRA, taxes are due. If you’re not 59½ or older, you could also pay a 10% early withdrawal penalty. Surviving spouses should try to minimize taxes on retirement account withdrawals to help the money last as long as possible.
Paying Taxes on Retirement Account Withdrawals Too Early. A surviving spouse can transfer tax-deferred retirement account assets into his or her name. That frequently lets a person further delay taxation. If you are under 70½, you can defer taxes into the future.
Paying a 10% Early Withdrawal Penalty. If the surviving spouse isn’t yet 59½ and needs some of the money in a retirement account, you can transfer the money into an inherited spousal IRA. If you need money, the IRS will let you take distributions. You’ll have to pay taxes, but you avoid the 10% penalty.
Required Minimum Distributions (RMDs). Distributions from retirement accounts are required after age 70½—even in the year when the spouse passes away. If the decedent was in payout mode and past 70½, make certain that between the decedent and beneficiary, you still take the required minimum distribution. If you forget, there’s a possible penalty of up to 50% of what you should have taken.
Advice. It’s not easy or practical to delve into your finances, right after losing a loved one. Don’t make any big money moves without advice. Remember to also incorporate tax planning with your estate planning, and work with an experienced estate planning attorney.
Reference: U.S. News & World Report (February 15, 2019) “Don't Make These Mistakes When Your Spouse Passes Away”