Issue 36.10
What will you leave your spouse with when you leave this world? Will your surviving spouse be stuck in a tax nightmare? Unfortunately the majority of couples do just that – and sadly, aren’t aware of it.
Let’s set our scene in a typical situation with a husband and wife. From a tax perspective, while both are living, they file jointly. This, of course, means that they have 2 standard deductions and 2 personal exemptions.
If they can keep their taxable income (Average Gross Income – Deductions & Personal Exemptions) below $68,000, they’ll still remain in the 15% tax bracket – but what happens when one of them dies? Suddenly, the surviving spouse only gets 1 standard deduction and personal exemption, not 2. Plus they can only have a taxable income of $34,000 or less to stay in the 15% bracket.
Too often the end result is a surviving spouse finding themselves with less income and paying more taxes because they move into a higher tax bracket.
Enter: The Killer
Take a moment to think about where most of your money is. If you’re like most people, most of your money is in your IRA or another similar retirement account. Each and every dollar withdrawn from these accounts is taxed at the highest tax rate. While you’re alive, that’s probably 15% – but for your surviving spouse, it’s more like 25%.
It’s time to think about what kind of legacy you’re leaving your surviving spouse. They will probably need to take distributions to make up for the lost income due to your death – but those very same distributions will be taxed at the much higher single rate.
Enter: The Solution
Don’t you think it’d be far better to leave your surviving spouse a tax-free account instead? Instead of leaving them $500,000 in a taxable IRA, which at the 25% tax bracket, actually only leaves them $375,000, wouldn’t it be better to leave them $500,000 tax-free, which is $500,000?
So, the question remains, how do you do that?
If you don’t need to take distributions for income from your IRA now, why not withdraw a small percentage each year, pay the tax while you’re both alive (so you get that lower filing jointly rate) and use the after-tax toward a tax-free account.