A Bargaining Chip in Alimony: IRAs
The loss of alimony deductions puts more money into Uncle Sam’s pocket and potentially leaves less cash for the recipient of spousal maintenance. As we all know, with the inception of the Tax Cuts and Jobs Act (TCJA), alimony for divorce settlements drafted after 2018 are now taxable to the payor spouse who is often in a higher tax bracket than the recipient.
So, how about utilizing an IRA asset to create a lump sum payment? Under the new law, IRAs provide new opportunities in alimony planning if certain conditions exist.
Hypothetical Example: Ralph and Missy have been married for 25 years. They have completed the division of their assets. In addition, their marital settlement agreement requires Ralph to pay spousal maintenance for 10-years at $10,000 per year. Ralph’s income tax bracket is 35%. Missy’s tax bracket is 12%.
Consider the following:
- If Ralph pays Missy her $100,000 periodically over 10-years, his tax liability at 35% will be $35,000. His out-of-pocket increases to $135,000.
- Alternatively, Ralph makes a lump-sum payment by rolling over $112,000 of his remaining IRA assets to Missy. He’s covered his $1000,000 alimony obligation plus added $12,000 to cover Missy’s taxes for when she takes distributions under her separate name
- By transferring the income tax liability back to Missy by means of an IRA Rollover, Ralph potentially saves $23,000 as follows:
$ 35,000 – Tax liability if Ralph pays alimony overtime
(12,000) – Advanced to Missy to cover her taxes
$ 23,000 – Potential Tax savings for Ralph
This strategy works best when the receiving spouse has time before taking withdrawals possibly from other assets through the property division for equitable distribution. This allows the continuation of tax-deferred growth on a retirement asset. Admittedly, there are pros and cons to consider when calculating lump sum marital support as part of a settlement and may not be warranted in every situation. A Certified Divorce Financial Analyst® (CDFA®) professional can provide 10 and 20-year cash flow projections to assist clients.
Investment Advice offered through The Financial Knot, a registered investment advisor.