As most of our readers likely know, spousal support (alimony) payments stopped being deductible for the payer for any divorces finalized after 2018. They’re no longer taxable for the payee as income, either. Those were just two of many changes included in the Tax Cuts and Jobs Act.
Those changes – particularly the elimination of the tax deduction – have led many family law attorneys and their clients to seek more creative solutions to support obligations than the traditional monthly payments as they plan for their post-divorce financial well-being.
One of these involves individual retirement accounts (IRAs). These have become an increasingly popular alimony bargaining chip for divorcing couples. One spouse (generally the larger earner) pays alimony in a lump sum by giving an IRA to the other.
Since withdrawals from IRAs are taxed as income, the spouse who’s in a higher tax bracket would likely pay more in taxes on withdrawals from the IRA than their soon-to-be ex would. If they’re over 59 ½ , they also have to pay a 10% penalty. However, by transferring it to a spouse in a divorce, there are no taxes or penalties involved.
An option for older couples
This solution is best for older couples, where the recipient spouse is over 59½ and pays no penalties for withdrawing money from the IRA. They will pay taxes on the withdrawals, but probably at a lower tax rate than their spouse would have.
One certified public accountant says, “When the husband gives the IRA to his ex-wife, he’s giving money he would have paid taxes on. He is in effect getting a deduction.” (Of course, these situations don’t always involve this traditional gender stereotype of alimony.)
In addition to older couples, this could be a good solution for spouses who are receiving alimony, but don’t need the money to live on, at least immediately. If you can afford to wait to until you’re old enough to avoid the 10% penalty, an IRA may be a good choice as a source of alimony.
Whichever side of the spousal support equation you’re on, it’s wise to discuss the various options and the tax impacts of all of them with your family law attorney as well as with a trusted financial and/or tax advisor.