The Tax Cut and Jobs Act (TCJA) that went into effect this year for divorcing couples has drastically changed the financial landscape for individuals from prior years. The most significant change is that spousal support (alimony) is no longer deductible if paid or taxable income if received. Many states, including Colorado, have updated spousal support guidelines to take into consideration these modifications. Overall, these changes have effectively reduced financial resources for both spouses because Uncle Sam is receiving a larger slice of the pie. Although this repeal has been a headline story in the media, what other financial issues have been affected and are there any new planning strategies to help navigate the new terrain?
Most notably, the individual paying spousal support will have a significantly higher tax burden. Therefore, their ability to claim other tax deductions such as medical deductions (taxpayers can deduct medical expenses that exceed 10% of their AGI) or any tax incentives available that are linked to income have also been affected. Eligibility to participate in a Roth IRA may also be more difficult to qualify for since contributions are only available to taxpayers with an AGI of $122,000 or less in 2019. Higher income earners may also find themselves paying the 3.8% Medicare surtax that is levied upon single taxpayers with incomes above $200,000 whereas married couples filing jointly weren’t subject to this tax until their income was above $250,000.
According to the Pew Research Center, ‘Grey Divorces’ for those over the age of 50, have doubled over the past 25 years. This combined with the recent tax overhaul has made saving for retirement significantly more challenging during a period of time where most couples are trying to make the most of their last minute savings efforts.
Most spousal support recipient’s over the age of 50 have spent the past 20+ years tending to family at home, relying on their spouse's income to build their nest egg, and now depend solely on spousal support for the majority of their income. These spouses, with no earned income, are not eligible to contribute to an individual retirement account (previously spousal support was considered pass through ‘earned income’ and was eligible to contribute to individual retirement accounts). Therefore, the ability to save for retirement during the last leg of the race before retirement has been significantly hindered if additional employment is not obtained or considered during divorce proceedings.
A stark difference between taxable and non-taxable spousal support has completely changed the financial landscape for many divorcees. Change can be challenging however, when we are able to re-frame change we can also find opportunity. This year while working with divorcees it has been my goal to uncover just that - what are the opportunities in this new environment? The following are some examples of what has surfaced for spousal support recipients:
*Spouses with extremely low taxable income will be able to deduct a larger portion of their medical expenses that are over 10% of their AGI.
*Individuals working part-time earning less then $15,570 this year while receiving support will qualify for the Earned Income Tax Credit that wouldn't have been available in prior years.
Creating Tax-Free Retirement Income:
Retirement planning opportunities may exist especially for the Grey Divorcee's who can take advantage of the vast difference in taxable income before and after retirement. The following graph shows the significant difference for a 55-year-old receiving $50,000/yr in tax-free spousal support plus earning $20,000/yr through employment versus at age 67 years when spousal support ends and nearly all income sources are completely taxable: