Maintenance payments will be subject to new tax regulations from 2019. That could mean big changes for your retirement savings.
It’s all part of the Tax Cuts and Jobs Act, which was introduced by Congress late last year.
Under the new rules, the person who pays alimony to a former spouse can no longer deduct these payments. And the recipient of the money will no longer pay tax on this income.
The law applies to divorce agreements concluded after the New Year.
“If you were already getting maintenance payments and you would get them for another 20 years, the new law doesn’t affect you,” said Ed Slott, founder of Ed Slott & Co.
However, if you get divorced after December 31st, the way these payments can be made and what you can do with the money received will change when it comes to your retirement accounts.
Payments through pension funds
If you are paying alimony, current regulations require you to pay in cash to receive a deduction.
But for divorce settlements made after the new rules came into effect, you can transfer funds from your retirement accounts instead.
That could offset the impact of the new rules, Slott said.
For example, if a spouse makes payments through an individual retirement account, they are giving money that they would otherwise have to pay tax if they had withdrawn, Slott said.
Once a receiving spouse takes money from the IRA, they will pay tax on that money.
“This gives you the same advantage that you would have had before the tax regime changed,” said Slott.
To take money from an IRA, the receiving spouse must be at least 59½ years old. Otherwise, they will have to pay a 10 percent penalty on these withdrawals in addition to the taxes they would normally owe on that money, Slott said.
A referral from an IRA would be a one-time transaction that would need to be formally regulated in a divorce settlement. To increase your cash flow, you may want to get just part of your living from a pension fund, said Megan Gorman, managing partner at Checkers Financial Management.
“This is where it is critical to have a financial planner or a CPA or a CFP involved in the process,” said Gorman. “You can run into different scenarios where you might get part of your alimony through monthly payments, but another part of that will be paid to you in a lump sum through an IRA at the time of the divorce.”
The person liable for maintenance should also carefully check whether the use of funds directly from their retirement assets makes sense and does not endanger their financial stability.
Retirement savings restrictions
The new tax rules could limit the way dependents save for retirement.
Since this money is no longer considered to be taxable income, it is no longer possible to invest this money in an individual pension account.
“For someone out of work and just living, this could change the options for a retirement plan,” said Jennifer Silvas, senior tax associate at Sensiba San Filippo, an accounting and management consultancy firm.
If you have other income, you can invest this money in a pension plan.
If you don’t, you can still deposit the money you would have deposited into an IRA or 401 (k) plan into a taxable account.
“Most Americans are not strong savers, so don’t use this as an excuse not to save for retirement,” Gorman said. “Any money you put away is helpful.”
More from Personal Finance:
Act now if you want to maintain this tax break in the event of a divorce
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