Much has been said about the short-term impact of a divorce on your emotional and mental well-being. What many divorcees and people about to file for divorce fail to consider, however, is just how bad a divorce can be for their retirement readiness.
According to a report from the Center for Retirement Research at Boston College, half of American households are at risk of being unable to maintain their desired standard of living during their retirement years. The risk is worse for divorced spouses—higher by 7 percentage points.
The reason is simple, if you think about it. Couples benefit from economies of scale when they’re married, combining their incomes and splitting the costs of housing, food, and utilities. Many divorced spouses, however, are unprepared for the financial shock of continuing their standard of living now that they have a smaller income stream. This strain on their finances can also affect their ability to save for retirement.
What About Alimony?
Alimony, or spousal maintenance or spousal support, has long been the financial lifeline for many divorce spouses, allowing them to maintain some aspects of their desired standard of living. Alimony is paid by the higher-earning spouse to the lower-earning spouse, ensuring that the latter can still support himself/herself after ending the marriage.
It used to be that the supporting spouse, or the person paying alimony, could deduct this expense from their gross income for tax purposes, while the spouse receiving alimony is required to report it as income. In some instances, the higher earning spouse’s tax savings make it possible for him/her to pay more alimony.
But this could all change with the Tax Cut and Jobs Act, which removes the ability for spouses divorcing in 2019 and beyond to claim a tax deduction from alimony payments. Likewise, people receiving alimony can no longer report it as part of their income.
This has the effect of slashing the amount of money the higher-earning spouse can pay as alimony, raising the risk of the receiving spouse finding himself/herself in a worse financial situation. If this happens long enough, the receiving spouse’s ability to retire in comfort could be compromised.
Financial to Prepare for During and After Divorce
To protect your retirement readiness, there are a number of financial strategies you can look into:
Investments – if you’re a person receiving alimony, receiving a smaller amount could place you in a lower tax bracket (alimony is no longer reportable as income), which in turn, means you may qualify for a 0% tax rate on your capital gains. During property division, you can use this to your advantage by negotiating to receiving investment assets instead of the marital home. This should help you stay in a better position to retire with cash in your pocket.
The family home – Keeping the marital/family home in a state with high property taxes may be more disadvantageous in light of the new tax law, which limits state and local tax deductions at $10,000 a year. You may be better off renting a smaller home and claiming the new larger tax deduction. If you’re in your senior years, you can take out a reverse mortgage to use your equity and buy a new home.
If you want to learn more about protecting your finances and retirement readiness during and after a divorce, schedule a consultation with family law attorney Daniella Lyttle of the Lyttle Law Firm. Call our offices at 512.215.5225 to find out how we can help you.