- New divorce settlements will be subject to new tax rules from 2019 thanks to the Tax Cuts and Jobs Act.
- People who make payments to their ex-spouses can no longer deduct this money. The recipients no longer pay taxes on this income.
- The new rules also introduce changes to how divorced people may or may not use retirement accounts on either side.
Child support payments are subject to new tax regulations from 2019. That could mean big changes for your retirement accounts.
It’s all part of the Tax Cuts and Jobs Act, which passed Congress late last year.
Under the new rules, the person who pays alimony to an ex-spouse can no longer deduct those payments. And the recipient of the money will no longer pay taxes on this income.
The law applies to divorce settlements entered into after the New Year.
“If you were already receiving child support and would receive it for another 20 years, the new law will not affect you,” said Ed Slott, founder of Ed Slott & Co.
However, if you divorce after December 31, it will change how those payments can be made and what you can do with the money you receive in your retirement account.
If you are making child support payments, under applicable regulations you must pay cash to get a deduction.
For divorce settlements entered into after the new rules go into effect, you can transfer funds from your retirement account instead.
That could offset the impact of the new rules, Slott said.
For example, when a spouse makes payments through an individual retirement account, they are donating money that would otherwise have been taxable if they had withdrawn it, Slott said.
Once a receiving spouse receives money from the IRA, they must pay tax on that money.
“That way you create the same advantage that you would have had before the tax regime changed,” Slott said.
To receive money from an IRA, the receiving spouse must be at least 59½ years old. Otherwise, they would have to pay a 10 percent penalty on those withdrawals, in addition to the taxes they would normally owe on that money, Slott said.
A transfer from an IRA would be a one-time transaction that would need to be formalized in a divorce settlement. “To expand your cash flow, you may want to receive just a portion of your maintenance from a pension fund,” said Megan Gorman, a managing partner at Checkers Financial Management.
“This is where getting a financial planner or a CPA or CFP involved in the process is key,” Gorman said. “You can play through different scenarios where you might receive part of your alimony in monthly payments, but another part of it will be paid to you as a lump sum through an IRA at the time of divorce.”
Likewise, the maintenance debtor should carefully consider whether the direct use of funds from his retirement savings makes sense and does not endanger his financial stability.
The new tax rules could limit how dependents save for retirement.
Since these funds are no longer considered taxable income, it is no longer possible to invest this money in an individual retirement account.
“For someone who doesn’t work and only has alimony, that could change what you can invest in for retirement,” said Jennifer Silvas, senior tax advisor at Sensiba San Filippo, an accounting and business consulting firm.
If you have other income, you can invest that money in a retirement plan.
If you don’t do this, you can still put money that you would have paid into an IRA or 401(k) plan into a taxable account.
“Most Americans aren’t big savers, so don’t use this as an excuse not to save for retirement,” Gorman said. “Any money you save is helpful.”
More from Personal Finance:
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