By Laurie Itkin
In January, thousands of Americans will file for divorce. Traditionally, January can be a busy time for divorce filings as November and December are slow months due to the holidays. Even our current President would find serving a spouse with divorce papers over a Thanksgiving or Christmas turkey dinner to be uncouth.
The standard of living of both spouses often drops after divorce because the same overall income and assets now has to support two households instead of one. In my experience, few people prepare themselves financially or emotionally for that consequence. Divorces that are initiated in 2019 will be even more financially challenging than those initiated in previous years for three primary reasons:
- Historical change to how alimony is taxed which will result in lower awards.
- Reduced ability for non-working alimony recipients to save for retirement.
- The rising cost of home ownership.
Now, more than ever, working with a divorce financial planner such as a certified divorce financial analyst (CDFA) is crucial in ensuring that you can thrive financially after divorce.
Historical Change to How Alimony is Taxed Will Result in Lower Awards
For divorces finalized on or after January 1, 2019, alimony (also called “spousal support” or “maintenance”) is not tax-deductible to the payor. (For divorces that were finalized prior to this date the tax treatment of alimony may be grandfathered.) That was one of the unwelcome changes in the Tax Cut and Jobs Act of 2017 (TCJA) and is resulting in alimony awards being lower than in the past. Why? Because, typically, the spouse paying alimony was in a higher tax bracket than the spouse receiving alimony and less was paid in income tax by the recipient than what the payor saved in taxes.
Having to pay alimony with after-tax dollars means that payers cannot afford to pay as much as when alimony could be paid with pre-tax dollars. It was forecast that changing the way alimony is taxed would raise $8 billion for the federal government over 10 years. A portion of money that previously flowed from one ex-spouse to the other will now go to the government. Your divorce financial planner can help you prepare a post-divorce budget that takes into account this new reality.
Reduced Ability for Non-Working Alimony Recipient to Save for Retirement
For divorces finalized on or after January 1, 2019, alimony recipients do not pay income taxes on alimony. This might sound good but not only will the amount of alimony be lower than under the previous tax regime, it can no longer be used to contribute to a retirement account. Prior to 2019, when alimony was considered “earned” taxable income to the recipient, he or she was able to contribute $5,500 (or $6,500 if over age 50) each year into an individual retirement account (IRA).
For example, if a 50-year-old non-working woman received alimony for 15 years and decided to deposit $6,500 each year in her IRA, over the 15 year period she would have deposited a total of $97,500. If her investments returned 5% annually, she would have earned nearly $50,000 in investment growth giving her a total of $147,000 at age 65.
But now, since alimony is not taxable, if she doesn’t have a job she will not be able to contribute to a retirement plan. Even if she has other sources of income like rental or investment income, she cannot use these income sources to contribute to a retirement account because they are not considered “earned” income. Your divorce financial planner can forecast at what age you might run out of money and can provide recommendations on what you need to do now to avoid that from happening.
Rising Cost of Home Ownership
When a married couple who owns a house gets divorced, typically the couple sells the house or one spouse stays in the house and takes sole ownership of it after “buying out” the other spouse.
Unfortunately, home ownership has become more expensive. Although the provisions in the TCJA impacting home ownership took effect in 2018, those impacts are just starting to be felt. The TCJA capped the amount of property tax that can be deducted and also eliminated the deductibility of home equity lines of credit (unless used for capital improvements and other exceptions). This is leaving many homeowners with less disposable income than in previous years.
When I meet with a new client, I find that some who hold mortgages jointly with their spouse assume that they can simply take their spouse’s name off the loan and keep the current interest rate and the house. They are surprised and disappointed when they find out this is not the case.
A spouse who wants to stay in the house will likely need to refinance the existing mortgage in his or her own name. Gone are the days of the 30-year, 3.75% fixed-rate mortgage. The Federal Reserve Board has been increasing interest rates and plans to continue doing so in light of how strong our economy is in contrast to how it was during the financial crisis a decade ago.
Depending on your credit score and other factors, interest rates for a 30-year fixed rate mortgage might start at 4.5% or 5%. A mere 1% increase in the interest rate can raise your monthly payments significantly. For example, for a $400,000 30-year fixed rate mortgage, monthly principal and interest for a 3.75% loan would be $1,852. At a 5% interest rate, the monthly principal and interest payment shoots up to $2,157, a $300 increase each month or $3,600 more each year. The bottom line is that the monthly and annual cost of home ownership is higher than it has been in recent years. Your divorce financial planner can help you quantify the pros and cons of owning versus renting.
And what about qualifying for a mortgage? If alimony is no longer considered income, will fewer people be able to qualify for mortgages? I do believe the mortgage industry will adjust but for the next year or two, this could be a challenge.
January is a Good Time to Start Gathering Financial Information
From January through March you and your spouse will be receiving (either in the mail or online) financial and tax statements that will be used to prepare your 2018 tax return. Start looking out for W-2’s, 1099’s, and K-1’s. Self-employed individuals such as sole proprietors will be starting to prepare profit and loss statements and Schedule C’s. Some self-employed individuals and small business owners may receive up to a 20% tax deduction on certain business income which might free up more money to go towards child support or alimony.
If you haven’t paid much attention to tax return preparation in the past, you’ll want to do so now. Your divorce financial planner can organize and decipher that information which will assist you in your child support and alimony negotiations.
Getting divorced this year might end up being more expensive than in the past so you’ll want to make up for it by not over-spending on legal fees. Here are seven ways to reduce legal fees in divorce.
About the Author
Laurie Itkin is a financial advisor, certified divorce financial analyst (CDFA), and the author of the Amazon bestseller, Every Woman Should Know Her Options. For less than the cost of a one-hour meeting with an attorney, her online course, Woman’s Guide to Financial Independence After Divorce, teaches separated and divorced women essential financial concepts. You can request a free consultation or subscribe to Laurie’s newsletter by visiting TheOptionsLady.com.