IRAs: A Powerful Bargaining Chip in Alimony
As we all know, with the inception of the 2017 Tax Cuts and Jobs Act (TCJA), alimony for divorce settlements drafted after 2018 are now taxable and not deductible to the payor spouse. This seems like a win for the receiving spouse who is receiving alimony tax free, but actually this just puts more money into Uncle Sam’s pocket and potentially leaves less cash for the recipient of spousal maintenance. Since the payor spouse is often in a higher tax bracket than the recipient, more money is going toward taxes, which leaves less cash for either party!
So, how about utilizing an IRA asset to create a lump sum payment when appropriate? Your Payor client may love it!
Under the 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 $100,000 per year. Ralph’s income tax bracket is 35%. Missy’s tax bracket is 12%.
Consider the following:
· If Ralph pays Missy her $1,000,000 periodically over 10-years, his tax liability at 35% will be roughly $300,000 with deductions. His out-of-pocket increases to $1,300,000.
· Alternatively, Ralph makes a lump-sum payment by rolling over $1,120,000 of his remaining IRA assets to Missy ($1,000,000 alimony obligation, plus added $120,000 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 $180,000 as follows:
$ 300,000 – Tax liability if Ralph pays alimony over time
(120,000) – Advanced to Missy to cover her taxes
$ 180,000 – Potential Tax savings for Ralph
This strategy works best when the receiving spouse has time before taking withdrawals from the IRA, 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 help clients and their attorneys understand how decisions in divorce will affect their financial future. Knowing this information will empower you to make better financial decisions at a difficult time in your life. Contact The Financial Knot® today to learn how we can help!
The Financial Knot® is another business name for Independent Advisor Alliance, LLC. All financial planning advice is offered through Independent Advisor Alliance, LLC, a registered investment advisor.
