Why separating couples might want to finalize their divorce by the end of 2018

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Why separating couples might want to finalize their divorce by the end of 2018

If you are in the process of getting divorced, there's a big financial reason to make the separation official by the end of 2018.

Following the passage of last year's Tax Cuts and Jobs Act, the deduction for alimony payments won't apply to any divorce finalized after Dec. 31.

As a result, "a lot of couples are in a push to get cases ... completed and to get divorced at the end of the year," says Brian Moskowitz, a divorce lawyer in Boca Raton, Florida. "It's going to cost the couple money if they don't."

How the new tax law treats alimony payments

Many divorce decrees require the higher-income party to provide financial support — alimony — to the lower-income party. For divorces completed before Jan. 1, 2019, the higher-income divorcée can deduct alimony payments from their annual income each year, while the lower-earning divorcée pays taxes on the income.

For divorces completed after Dec. 31, 2018, the onus shifts. The higher-earning divorcée can't deduct alimony payments. The lower-earning divorcée receives those payments tax-free.

That sounds like a raw deal for higher-earners, but it can also negatively impact alimony recipients.

“There’s the expectation that alimony amounts will decrease,” Chris Chen, certified financial planner and CEO of Insight Financial Strategists, says. That's because spouses with larger incomes will be less likely to agree to high alimony payments.

“Before the lawyers could use alimony as a bargaining chip in the proceedings,” Moskowitz says. “Now, it removes that trustability and can lead to more bitter separations.”

A possible backdoor for alimony payments?

For couples unable to get their divorce finalized by the end of the year, there is one loophole to talk through with your attorney: The higher-earning party could make alimony payments as a lump sum from their traditional individual retirement account to an IRA in the recipient's name, Chen says.

Contributions to traditional IRAs aren’t taxed until the money is withdrawn, meaning the recipient would end up paying the taxes on the allotted alimony. But this method is “really only ideal for older couples with a short alimony of five to ten years,” Chen says.

The higher-earner would need a lot of money in their IRA account to make payments this way. Meanwhile, the recipient couldn't withdraw the money until he or she was 59-and-a-half, so if they needed the payments quickly and they were under the age limit, they would pay a hefty tax to withdraw. (Learn more about IRAs.)

“Also, if you take that money out of someone’s retirement fund, what are they going to do in retirement? It’s robbing him or her of that capital,” Chen says.

If you were to utilize this strategy, both parties would need to agree to the payment structure in the divorce decree.

If you are getting divorced now

With the deadline just a couple weeks away, there may not be enough time to finalize a divorce before the alimony deduction goes away — especially if you just filed.

Given the complexity and weight of the situation, couples shouldn't feel pressured into a hasty legal separation. Still, they should sit down and have a discussion about what the best moves are for both parties, Moskowitz says.

“As long as they don’t completely hate each other, they should be able to have an educated conversation about [alimony],” he adds. “Especially if there’s kids involved.”

Another oft-overlooked money matter for separating couples? Many divorce decrees require you maintain or buy life insurance with your ex-spouse. Divorce is also an instance where it might make sense to own a policy on someone else – namely, your ex. That way, you and your children are protected from loss of income in a worst-case scenario. We can help you compare and buy life insurance across companies during a divorce. You can learn more about updating all your insurance policies post-separation here.

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