Understanding the Impact of Divorce on Retirement

May 7, 2019

Divorce_and_RetirementAs the saying goes, breaking up is hard to do. Still, the current divorce rate stands around 40 percent, having declined from around a 50 percent marriage failure rate in the 1980s.1

While the overall decline is generally seen as a good thing, the marital outlook for older Americans isn’t as promising. According to Pew Research Center, the divorce rate for Baby Boomers age 50 and older has more than doubled in the last 25 years.2

Divorcing at any age is difficult, both emotionally and financially, but those who divorce later in life often face greater challenges that can leave them ill-prepared for retirement and less financially secure.

As an advisor, you likely know some clients who are or will be facing this difficult decision. You can help them navigate some of the uncertainties by making them aware of the potential financial implications of divorce.

Taxes and Investments

Much has been made about the impact that the new Tax Cut and Jobs Act (TCJA) is having on businesses. But little has been reported on the implications these new regulations have on divorcees. Prior to 2019, someone who paid spousal support or alimony to an ex-spouse could deduct the expense from federal income taxes, and the person receiving alimony payments was required to claim them as taxable income.

As of 2019, however, those who file for divorce and are required to pay spousal support will no longer be able to claim a tax deduction, nor will recipients be required to claim any payments as income. Without the potential tax deductions, spouses with higher earnings may not be able to afford as much spousal support, meaning those who receive payments may not get as much.3

As a result, those receiving alimony may end up in a lower tax bracket and may qualify for a 0% tax rate on capital gains. Depending on his or her unique situation, a spouse with fewer earnings may want to receive investment assets rather than a property settlement.3

If taxes weren’t confusing enough to begin with, it’s generally business as usual for divorce agreements executed prior to 2019. And, to top things off, the TCJA rules expire at the end of 2025.4

Child Tax Credits

The tax burden for divorced individuals with children has generally been reduced as a result of new rules under the TCJA, and more valuable tax credits have replaced personal exemption deductions.

The maximum child tax credit doubled from $1,000 per child prior to the 2018 tax year to $2,000 currently. The key term there is “maximum,” meaning that not everyone who qualifies will receive that much. With the new TCJA, up to $1,400 of the $2,000 may be refundable, but a parent must have a certain level of earned income to qualify. Of note for your clientele, however, is that investment dividends and payments are not considered “earned income.”5 Once again, this rule is expected to expire in 2026.

Higher Cost of Living

An average divorce costs more than $15,000, with legal fees accounting for the majority of expense.6 This price tag often creates a financial burden on individuals in addition to the emotional toll of dissolving a marriage. For divorces that are contested or those involving battles over child custody, the costs may be significantly higher.

Once the divorce is final, the financial struggles often continue, especially for those who divorce later in life. Married couples typically share many cost-of-living expenses including housing, utilities, food, and more and, after they part ways, the full financial responsibility for those expenses falls on each. About half of households in the U.S. are already at risk of not being able to maintain their standard of living in retirement and, for divorcees, that number jumps 7 percent higher.3

Social Security Benefits

Older divorced clients who were married for more than 10 years may be eligible to receive a portion of their ex-spouse’s Social Security earnings. Some divorcees are unaware of this potential benefit, so it’s important to talk with your clients to ensure they take full advantage of any potential earnings that could supplement their income during retirement.

According to the Social Security Administration, the following guidelines apply:7

  • The potential recipient is unmarried;
  • Is age 62 or older;
  • Has an ex-spouse that is entitled to Social Security retirement or disability benefits; and
  • The benefit the potential recipient is entitled to receive based on his or her own work is less than the benefit based on the ex-spouse's work

Additional stipulations are in place, so be sure to have your client check with the Social Security Administration for full details.

Helping clients who face the decision of divorce can be difficult, especially if you’ve built a strong relationship with each of them over the years. Couple that with the decisions they may need to make about future investments during volatile markets and the challenge becomes even harder. Help them navigate their feelings by accessing our guide, Defusing Emotions: An Advisor’s Role in Disciplined Long-Term Investing. Click the button below to access your copy now.

Defusing Emotions: An Advisor’s Role In Disciplined Long-Term Investing

SOURCES:

1Time, The Divorce Rate Is Dropping. That May Not Actually Be Good News, November 26, 2018

2MarketWatch, This is Why Baby Boomers are Divorcing at a Stunning Rate, October 20, 2018

3InvestmentNews, Divorce Reduces Retirement Readiness, June 19, 2018

4MarketWatch, New Tax Law Eliminates Alimony Deductions — But Not For Everybody, January 29, 2019

5The Balance, The Child Tax Credit: 2017 vs. 2018, January 29, 2019

6USA Today, How Much Does it Cost to Get a Divorce? 10 States with the Highest Price Tags, November 26, 2018

7Social Security Administration, If You Are Divorced, undated

MGA-2454017.1-0319-0421


Topics: Retirement