As Bill Harris says in his book Inheriting Your Spouse's IRA, “Many decisions have to be made within a certain timeframe. They often cannot be reversed. So, you'll have to get this done right the first time or suffer the tax consequences.”
Unfortunately, we see a lot of people who are entering widowhood and mishandle the crucial transaction of inheriting their spouse’s IRA.
As a result, the number of widows ending up in tax courts is high. This is the last thing a widow wants to deal with while coping with the tragic loss of their partner.
To address this common problem, we invited Bill Harris, an advisor specializing in financial planning for widows, to one of our recent podcast episodes. There, he shared his ideas and strategies to help widows make informed financial decisions.
In this blog, we’ll outline an easy-to-follow 4-step guide to help widows navigate the emotionally overwhelming path of widowhood so they can make better money decisions.
1. Understand That You Have Plenty of Time to Plan
One of the first things that we tell people when they become widowed and have a major inheritance to deal with is that there’s absolutely zero rush.
You have until September 30th of the year following your partner’s death before you need to make any major decisions. This means that you have at least nine months or more to get your finances in order.
We advise you to take this time to cope with your grief and sorrow instead of rushing into irreversible choices that’ll stick with you for the rest of your life. Believe it or not, a lot of people don’t even remember making any decisions during their first year into widowhood. They’re so overwhelmed that they’re just not in the right frame of mind to plan their finances.
2. Find the Right Advisor To Guide You
We can’t stress enough the importance of finding the right advisor to guide you during your entry to widowhood. After all, the decisions you’ll make during this time are going to have lasting impacts on your finances.
There are some advisors, like Bill Harris, who specialize in financial planning specifically for widows. Having such a specialist advisor by your side, as opposed to a general advisor, can make a huge difference.
We’ve seen incidents in the past where some clients have suffered a huge loss only because their advisors were misinformed about a particular topic and failed to give them the best advice.
To evaluate if a particular advisor is right for you, one of the things that you can look at is how dedicated they are in continuously learning and expanding their pool of knowledge. Legislative rules and regulations, various tax codes, retirement benefits, and more are always changing. An advisor must keep themselves up-to-date with the latest trends.
For instance, Jeremy Keil chose to pursue various designations such as the CFP®, CFA, CIMA® and many others. Even today, he continues to attend various conferences and strives to learn new things so his clients can take advantage of the latest trends. Similarly, through Ed Slott’s Elite IRA Advisor Group, the RMA® certification, and other resources, Bill Harris broadens his expertise as a financial advisor.
To learn more about finding the right advisor for you, check out our Blog: 3 Ways To Find The Best Advisor For You.
3. Beware of the Widow’s Penalty
As we mentioned earlier, a lot of people mishandle the transaction of inheriting their spouse’s IRA. Sometimes, this can lead to a 10% ‘widow’s penalty!’
To understand when and how this penalty is imposed, first, let’s mention that there’s a difference between rolling over your spouse’s IRA into your own IRA versus moving it into an inherited IRA account.
How do you determine what’s best for you? By looking at your age.
If you’re under the age 59½ and you transfer money from your spouse’s IRA to move it into your own, you’ll have to pay regular income tax on it as well as a 10% penalty on any money you take out before you turn 59½.
However, if you’ve opted to move your spouse’s IRA into an inherited IRA, then you can withdraw the money penalty-free (you would still owe income taxes). This also holds true for other retirement savings vehicles such as 401(k)s. This means that transferring the money from your spouse’s 401(k) to your own IRA can lead to a 10% penalty as well.
We’ve seen widows as young as 40 or 50 who unfortunately got the wrong advice, transferred their spouse’s IRA into their own IRA, and were faced with a potential 10% penalty for the next 10-20 years! All because their advisor was misinformed!
While planning your taxes, you’ll also need to consider the expected shift in your income tax bracket. When you start filing your taxes as a single person, even though your income might not have changed significantly, you could still end up in a higher tax bracket. We often see widows feeling the impact of this shift during their second year into widowhood which is when they actually start filing as single.
4. Make the Most Out of the Tax Benefits Offered To Widows
In the case of an inherited IRA, there’s a special provision for the inheriting spouse that doesn’t require them to take required minimum distributions (RMDs) unless their spouse would have been taking RMDs.
Moreover, even if you decide to roll it over into your own IRA after age 59½, you’ll still not be required to take RMDs until the age of 72 years (note that the SECURE Act of 2019 has increased the minimum age for RMDs from 70 and ½ years to 72 years.) This provision of avoiding RMDs can be a major benefit for widows from a financial planning standpoint.
A second advantage is that if you’re widowed during a particular year, you can still file as married filing jointly during the first year. This exemption is accompanied by a step-up in basis on your assets. Lastly, life insurance is another key tax-free vehicle that eases the financial burden on you.
You can utilize all of these various tax benefits to retain most of your inherited wealth.
Remember – as a couple, it’s a good idea to start planning early
When you’re heading into retirement as a couple, it’s not just about planning what things will look like for the two of you, but also about planning for the surviving spouse.
You can ensure that the surviving spouse doesn’t need to face tremendous financial difficulties by having some strategies in place well ahead of time.
This is why we always advise couples to financially plan for a scenario when one of them passes away as they might have to face it at some point in their life – and it’s better to be prepared for it.
To get a more in-depth understanding of how widows can optimize their financial picture, check out the book Inheriting Your Spouse's IRA: The Widow's Guide to Keeping More of Her Assets by Bill Harris.
To learn more about how Bill and his team guide widows through their financial future, check out WH Cornerstone Investments.
Finally, if you require any assistance with retirement, investment and tax planning, feel free to contact us!