Alimony payments will fall under new tax rules starting in 2019. That could mean big changes for your retirement accounts.
It's all a part of the Tax Cuts and Jobs Act that was ushered in by Congress late last year.
Under the new regulations, the individual who pays alimony to an ex-spouse will no longer be able to deduct those payments. And the recipient of the money will no longer pay taxes on that income.
The law applies to divorce agreements that are formed after the New Year.
"If you were already getting alimony and you were going to get it another 20 years, the new law doesn't affect you," said Ed Slott, founder of Ed Slott & Co.
But if you divorce after Dec. 31, it will mean changes to how those payments can be made and what you can do with the money received when it comes to your retirement accounts.
Payments through retirement fundsIf you are making alimony payments, current rules require you to pay in cash in order to get a deduction.
But for divorce agreements made after the new rules kick in, you will be able to transfer funds from your retirement accounts instead.
That could offset the effect of the new rules, Slott said.
If one spouse makes payments through an individual retirement account, for example, they are giving money that they otherwise would have had to pay tax on if they had withdrawn it, Slott said.
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Once a receiving spouse takes money from the IRA, they will pay tax on that money.
"By doing that, you're creating the same benefit you would have had before the tax rule changed," Slott said.
In order to take money from an IRA, the receiving spouse has to be at least 59½. Otherwise, they will have to pay a 10 percent penalty on those withdrawals in addition to the taxes they would normally owe on that money, Slott said.
A transfer from an IRA would be a one-time transaction that would have to be formally laid out in a divorce agreement. In order to expand your cash flow, you may want to choose to receive only part of your alimony from a retirement fund, said Megan Gorman, managing partner at Chequers Financial Management.
"This is where engaging a financial planner or a CPA or a CFP in the process is key," Gorman said. "They can run various scenarios where maybe you get a portion of your alimony through monthly payments, but another portion of it is given to you in a lump sum through an IRA at the time of the divorce."
Likewise, the party who is paying the alimony should also carefully assess whether using funds directly from their retirement savings makes sense and will not compromise their financial stability.
Restrictions on retirement savingsThe new tax rules could restrict the way alimony recipients save for retirement.
Because those funds will no longer be considered taxable earned income, it will no longer be possible to invest that money in an individual retirement account.
"For somebody who is not working and only receiving alimony, that could change what you're able to put into a retirement plan," said Jennifer Silvas, senior tax associate at Sensiba San Filippo, an accounting and business advisory firm.
If you do have other earnings, you could use that money to invest in a retirement plan.
If you do not, you can still put the money you would have put in an IRA or 401(k) plan in a taxable account.
"Most Americans are not strong savers, so don't use this as an excuse not to save for retirement," Gorman said. "Any money you put away is helpful."
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