It’s important for divorcees to review and adjust their W-4 payroll withholding or start to make quarterly tax estimates following their divorce. Often, they are so relieved to have reached settlement, they fail to think about these housekeeping items. If divorced in 2018, this is especially important if transferring taxable spousal maintenance. The payor spouse can likely change their payroll withholding to increase their net income. The payee spouse will need to withhold additional tax dollars on their salary or make quarterly estimated tax payments, to account for taxes on the spousal maintenance payments received. If the payor spouse doesn’t adjust their W-4, they may not be able to meet their budget during the year and would probably receive a large tax refund when taxes are filed. If the payee spouse doesn’t adjust their W-4 or start quarterly estimated taxes, they could have a large tax liability when they file their return. Even if there isn’t taxable spousal maintenance, individuals still may need to adjust their withholding. Things that can impact taxes and often require an adjustment are a change in their filing status, pre- tax payroll deductions (retirement contributions, health savings account, health insurance premiums), and itemized deductions such as real estate taxes and mortgage interest. Making these adjustments now will help cash flow match what was projected during the divorce process and save the headache later of a tax surprise.
As we move into 2019, it’s helpful to know contribution limits and Social Security changes. Individual Retirement Accounts: The annual contribution limits for traditional and Roth IRA’s have increased to $6,000, a boost of $500 over 2018 contribution limits. The catch-up contribution limit for those age 50 and older remains at $1,000. 401(k)s: The annual contribution limits for 401(k)’s, 403(b)’s, most 457 plans, and the federal government’s Thrift Savings Plan have increased to $19,000, a boost of $500 over 2018 contribution limits. The catch-up contribution limit for employees age 50 or older in these plans stays at $6,000 for 2019. SIMPLE IRA: The limit for SIMPLE IRA’s goes up from $12,500 in 2018 to $13,000 in 2019. The catch-up limit remains the same at $3,000 for those age 50 and older. Health Savings Accounts: The “self-only” annual contribution limit will increase from $3,450 to $3,500 and the “family” annual contribution limit will increase from $6,900 to $7,000 in 2019. Social Security Updates:
- Beneficiaries will see a 2.8% increase in payments
- Maximum taxable earnings will increase to $132,900
- Maximum benefit at full retirement age increases to $2,861 per month
It is important to review and discuss tax planning for the year in which a divorce was completed, especially for high earning individuals who receive incentive compensation and plan to be divorced by December 31, 2018. As part of the 2017 Tax Cuts and Jobs Act, many tax law changes became effective in 2018. One change was to the flat tax rate that is withheld by companies on incentive income such as bonus income, commission income, exercised stock options, and vested restricted stock. As of January 2018, the federal rate changed from 25% to 22%. The Minnesota state rate remains the same at 6.25%. Most highly compensated individuals have marginal tax rates above 22%, so tax on the above income types is under-withheld. To avoid an unpleasant tax surprise come April 15th, be sure to address this potential additional tax liability and come up with a plan to handle it. Some options to consider are:
- Estimate the tax liability now and include and allocate it as part of the property division.
- Include language to share in the tax liability when return(s) are filed next year.
- Consider whether it makes sense to load-up itemized deductions from the year to the higher earning spouse to help offset liability (i.e. real estate taxes, mortgage interest, charitable contributions).
When a joint investment account is divided, the financial institute will use only one Social Security number to report the earnings and thus only one 1099 will be issued for that account. For example, following their divorce, Dick and Jane divided their joint investment account and transferred their own share into an individual investment account solely in their own name, on November 1st. If the “primary” Social Security number on the joint account is Dick’s, he will receive one 1099 for the joint account earnings earned from January 1st– October 31st and a second 1099 for the individual account earnings earned on his individual account from November 1st – December 31st. And, Jane will receive only one 1099 for the individual account earnings earned on her individual account from November 1st – December 31st. If the goal is to share the tax liability for the joint investment account earnings, this can be accomplished in a few ways.
- The tax liability is projected during the divorce process and an adjustment is worked into the property division.
- The spouse who received the 1099 adds the investment income to their tax return and language is added to the decree outlining the agreement on how to share the tax liability at tax filing time.
- The spouse who received the 1099 can “nominee”the correct portion of investment income to the other spouse by filing a 1099 and 1096 with the IRS and furnishing a 1099 to the other spouse.
It’s that time of year again, when the trees become bare and days grow short, that one’s thoughts turn to health insurance. That’s right, the open enrollment window for renewing your existing health insurance plan or shopping for a new plan opens November 1st and runs through December 15th, 2018. For Minnesota residents, shopping for insurance means contacting a health insurance broker to get help in comparing different plans. Or, for those whose income qualifies them for financial help, applying and enrolling on the MNSure website. For those who live in states without their own exchange, plans can be compared on HeathCare.gov, the federal government’s national exchange site. Choosing the right health insurance plan depends on your family’s health and understanding which cost-sharing arrangement works best for you. The cost-sharing arrangement is how much you want to pay monthly for the insurance premium plus how much you are comfortable paying out-of-pocket for a doctor’s visit or medical procedure. You can pay less on a monthly basis for your premium if you are willing to pay more out of pocket for a doctor’s visit or medical procedure. The most prominent cost-sharing component is the plan deductible. This is the amount you pay every year before the insurance company pays its first dollar. Choosing a lower deductible amount and pushing the costs onto the insurance company sooner will result in a higher premium. By choosing the maximum deductible allowed, $7,900 for individual plans and $15,800 for a family plans in 2019, you will pay a lower monthly premium. Picking a high deductible plan with a lower premium may make sense for a healthy person who never needs health services, as well as someone comfortable with paying the out-of-pocket amount. Other ways that insurance plans share the cost is with co-pays and coinsurance. A copay is a fixed dollar amount that you pay every time you visit the doctor. That amount may be $30 with a typical insurance plan but it will be lower or possibly waived for a more expensive plan. Coinsurance is where the cost of a medical procedure is shared. The typical coinsurance arrangement kicks in after you meet the deductible amount. Then, you pay 20%, for example, of costs until you reach the maximum out-of-pocket limit amount. Finally, the out-of-pocket limit is the maximum amount that you will pay. It is the sum of the deductible plus the copays or coinsurance that you pay in any given year. Once you hit this limit, the insurance company pays 100% thereafter. This amount is established each year by the government as part of the Affordable Care Act. As noted above, for 2019, the maximums are $7,900 for individual plans and $15,800 for family plans. Once you understand how cost-sharing works, the cost difference between plans comes down to the services and prescription drugs that the plans cover. All plans are required to cover emergency services, hospitalization and maternity care, as well as mental health and substance-abuse treatment, at a basic level. All plans also cover the cost of an annual check-up and preventive care services (such as immunizations and mammograms) with any level of deductible. More expensive plans will also cover a greater level of preventative services, and higher levels of service, such as brand name drug coverage instead of generic-only drug coverage. So, as you rake up the leaves and pull out the winter coats, take time to review your health insurance plan because health insurance season will soon be here!
Your divorce is over. It’s time to start sorting through all the things you need to do, to get your financial life in order. Here are just a few tips to help you thrive financially, as you move into this phase of your life. Pay Off Credit Card Debt One of the most important steps to achieve your financial goals is eliminating credit card debt. Start by paying off the balance of one credit card at a time, by either:
- Paying off the highest interest rate credit card first, or
- Paying off the smallest balance first, then applying that payment amount to the next smallest balance
Spousal support that lasts more than a couple years may be subject to cost of living adjustments (COLAs). This is negotiated as part of your divorce settlement. As the cost of living goes up, spousal support can increase as well, to meet its intent of maintaining the ex-spouse’s standard of living. Fortunately, the State of Minnesota’s Office on the Economic Status of Women (OESW) provides a booklet that contains a worksheet and instructions for calculating the cost of living increase for spousal support, as well as child support. The OESW’s A Guide to Child Support & Spousal Maintenance Cost-of-Living Adjustments also has template forms for notifying the paying ex-spouse of the increase and an Affidavit of Service by Mail form. Why an Affidavit of Service by Mail form? Because if the paying ex-spouse does not increase the support as requested, the affidavit is proof that they had been notified. All these forms and worksheets should also be filed with the court administrator where the decree was filed. This is a lot of paperwork, but OESW’s guide also has a checklist to make sure all of the involved parties get the correct documents. One additional piece of information needed to complete the COLA calculations is the Consumer Price Index Table. This table is also maintained and available for download at the OESW website. The index numbers on this table are used to show the increase in the cost of goods and services over time. These index numbers are used in the calculations to determine how much spousal support (and child support) should increase to keep up. The table shows over 20 years of data but, if one is being diligent about requesting increases, only the index numbers from the past couple of years should be needed. The Consumer Price Index Table contains sets of price index numbers: the CPI-U shows how much prices have increased on average for the entire United States; the CPI-U MSP shows how much prices have increased in the Twin Cities Metropolitan area. Your divorce decree will likely indicate which set of index numbers you should use. Note that while using the CPI-U MSP can most accurately reflect the increase in prices in Minnesota, this set is updated twice a year, in January and July, and it takes an additional month for the updated figure to be published. OESW’s A Guide to Child Support & Spousal Maintenance Cost-of-Living Adjustments is easy to follow and doesn’t require too many calculations. If you are not good at math or filling out forms, it is a good idea to get help from a financial professional or your family law attorney. Link to the Guide Link to the Consumer Price Index Table
Divorce has a way of completely upsetting one’s expectations for the future. One day things are moving along just fine, and the next you are making decisions that will impact the rest of your life. One of the big decisions is whether or not to keep the family home. It may really be two questions: “Should I keep the house?” and “Can I keep the house?”. Let’s consider both in turn. Whether you “should” keep the home is more of an emotional question. What does the home represent to you? Often it is an emotional safe haven full of good memories that you have spent years getting just right. It could also be an emotional roadblock to moving forward with your life. “Can I keep the house?” is more of a financial question. Will your income post-divorce allow you to maintain the house? Will taking the house in the divorce mean forgoing other marital assets such as retirement accounts, that may be more valuable in the long run? Perhaps keeping the house will require keeping your ex-spouse as co-owner, do you want that? Due to its functionality, your house is an asset different from a stock or retirement account. So, in many cases, the decision is a compromise focused on the question: “How long should I stay in the house?”. If you are unsure of the best way to handle the house, there are 3 exercises that you should go through to determine your best decision or when you should expect to sell.
- Develop a post-divorce budget to see if you can afford to keep the home. Perhaps with child support it may make sense to stay. When the kids go, the house may need to go as well.
- Run a retirement projection to see how keeping the home will impact your retirement and other financial goals.
- Finally, list the benefits and tradeoffs of keeping the home. The benefits may be proximity to work and school. A tradeoff may be that you are now in charge of the upkeep.
Sometimes your teenage children think they know everything. Do they know that if they saved the $6 they spend each day on a super antioxidant smoothie (or caramel macchiato), in 8 years they could buy a 4-door sedan in soul red or titanium flash (1)? Below are 3 lessons you should teach them about the long-term financial impact of decisions that they will soon be making for themselves. Lesson #1: Over time, compound interest can make a little bit of savings grow to a very big amount One of the regrets many of us has, is that we did not start saving soon enough. The idea of compound interest is something that your kids will understand by the time they are in middle school. There are numerous online calculators you can use to show them how deciding to save their money and forego that daily splurge can turn into better investments (like a new car). Lesson #2: College is a very expensive but financially important decision As your high schooler starts to contemplate where they want to go to college, don’t leave them out of the financing discussion. Even parents who expect to cover the entire cost of college need to make their child understand that it is a significant investment in their future, and not a nonstop party. Let them know that by completing college, they will likely earn $1 – $3 million more over their lifetime than their classmates who didn’t (2). Lesson #3: Credit cards are a tool and not a new source of money Credit card debt is rampant among people of all ages, but studies have shown that outstanding balances ramp up quickly after college. Before, during and after college, make sure your child understands that credit cards are not free money. Talk to them about using credit cards only to the extent that the balance can be paid off each month. Revisit Lesson #1 and show them how fast the balance on a 20% credit card can grow out of control. The best way to drive these lessons home is to set a good example. Demonstrate good use of credit by paying off your credit cards monthly. Develop a budget and then communicate how sticking to it serves larger financial goals. It’s very likely that you have made some big financial mistakes in your life. Wouldn’t it make sense to share what you have learned so they don’t make them too? (1) Assuming $6/day, saved for 8 years, earning 6% after fees, the total is $22,403. This exceeds the base MSRP of a 185 horsepower 2016 Mazda 6 4-door sedan with 6-speed manual transmission in Titanium Flash Mica ($21,330). The same model in Soul Red Metallic is $21,630. (2) The Economic Value of College Majors 2015, Georgetown University Center on Education and the Workforce.
When divorcing, whether one spouse stays in the family home is often a pivotal decision. For most, there are several considerations that go into deciding whether to sell or stay. The tax impact of selling the marital home is unlikely to be at the top of that list, but with home values on the rise, it is worth understanding. The current tax rules are quite favorable to people realizing a gain on the sale of their home. The IRS allows each taxpayer to avoid paying capital gains tax on the first $250,000 of capital gain on the sale of one’s residence. That means that a taxpayer filing “single” could exempt the first $250,000. A couple filing “married filing jointly” can avoid paying taxes on $500,000 in gains. The capital gains tax on a $250,000 gain can range from $0 to about $75,000 so it is worth it for divorcing couple to make sure they cover this in their divorce arrangements. To qualify for the exemption, the IRS requires that the home meet the principal residence test, which is based on ownership, use and timing. For ownership, you need to have lived in the home for at least 2 years, (24 full months) in the 5 years before the sale. These 24 months do not need to be continuous. The use criteria require that the home be your principal residence for those 24 months. This can be an issue if one spouse was employed in another city, where they kept a second residence. One spouse meets the use test, but the other does not. Finally, the timing criteria requires that you have not excluded the gain on the sale of another home in the past 2 years. Tax law gives divorcing couples some leeway in these criteria. Transfer of home ownership between divorcing spouses is not considered to be a taxable event by the IRS. If ownership is not transferred during the divorce, detailing the home ownership arrangement in the divorce decree is key to minimizing taxes when selling the home later. An ex-spouse that continues to be an owner of the home but does not live there, can still use the exclusion if there is written documentation in the decree that lays out this arrangement. Dealing with home decisions during the divorce can be a complex. Be sure that in your home decision analysis, you are clear on your tax implications! And keep in mind that cabins, vacation homes and investment real estate generally will not meet the principal residence test, so they may have tax consequences when sold. For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.