Doubling since the 1990s, “gray” divorce, or divorce for couples age 50 or older, is on the rise. Whether they are in the final stretch of the working years or retirement, a gray divorce happens when a couple is typically at the peak of their earning years and accumulated substantial net worth.
Unfortunately, during a highly stressful and emotional life event, individuals can make poor financial decisions, impacting each spouse’s tax liability. The good news is that there are several options for couples to consider so they can divide their assets as equitably as possible while potentially reducing their tax obligations.
Retirement Plans
There’s no tax when transferring assets in a retirement plan, but tax will be due when funds are distributed from the plan. Splitting up a 401(k) plan or similar pension account requires a qualified domestic relations order (QDRO). A QDRO is a court order that assigns rights of an employee with a retirement plan to transfer some or all of the benefits to an alternate payee or spouse. It is sent to the plan administrator to divide the plan according to certain criteria.
The IRS treats retirement plan benefits received as part of a divorce settlement as if the recipient has received the benefits under their own retirement plan. The ex-spouse would even be able to roll over their share of funds from the retirement plan to another retirement plan. The rollover would be tax-free, and it would start being treated as the spouse’s IRA on the date of the transfer.
Don’t classify interim support as alimony
Although you may have moved out of the family home or filed for divorce, any payments you made to support your spouse before the divorce is final are not considered alimony by the IRS unless they are pursuant to a court order and specified as alimony.
Alimony payments are typically tax deductible by the person making the payments, and you may feel entitled to some tax benefit as a result of supporting your estranged spouse. However, the IRS only allows the deduction if support payments were outlined in a written separation or divorce agreement.
Home buying
If you plan on filing for divorce and know you will have a relatively “friendly” divorce, it might make sense to purchase a home before divorcing if one spouse can’t qualify to purchase a home on their own. Then, the couple can use previous tax returns to purchase the house, and the spouse with the higher income can buy out the other spouse after the divorce.
File under your married name
Although you may be itching to ditch your married name or to remove that hyphen, doing so on your tax return before your name is legally changed may delay your tax refund. The IRS checks your name against your record at the Social Security Administration (SSA).
If your tax return is due and your name has not been legally changed, file under your married name until your name change is official. Once you are ready to change your name, notify the SSA of your name change, if any. Then, you can use your new name to file tax returns.
