Financial Planning Through Divorce – Tax Considerations
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Article by
Kendra Erkamaa, CEO & Financial Advisor Triangle Financial Services, Inc.

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In this second of two articles in the series, we’re focusing on how taxes may affect the division of property during divorce. Divorce is already a painful process, but taxes have the potential to compound the pain more through confusion over new tax laws and changing finances with retirement and beyond.

In my opinion, the number one tax consideration through divorce should be how they are applied to assets and income. Remember that not all assets are created tax equal! We tend to categorize our assets into buckets:

Non-qualified/taxable assets
These assets have no special retirement tax laws and are subject annually to tax on income and capital gains. Examples are bank accounts, equity in real estate, individual and joint brokerage accounts, stocks, mutual funds and bonds that are all held outright. Also frequently overlooked are after-tax contributions to plans like a 401(k), which will require a phone call to the plan company to clarify. 

Pre-tax retirement accounts
Contributions to pre-tax retirement accounts are deductible at the time they are invested (subject to withdraw rules), grow tax deferred and are completely taxable when withdrawn as a distribution from the account.  Examples of these plans are Traditional 401(k), SEP IRA, Simple IRA and Traditional IRA.

Tax-free retirement accounts
These account contributions are made with after-tax funds (NOT deductible), grow tax deferred, subject to withdraw rules and tax free when withdrawn as a distribution after the age of 59 ½. The accounts may be subject to taxes and penalties for early withdraw prior to age 59 ½.  Example of these plans are Roth IRA, Roth 401(k), Roth 403(b) and any other Roth account. 

Life insurance products
Life insurance accounts have a deferral of taxes with income. Common examples of these are life insurance policies with cash value, fixed annuities and variable annuities.

In divorce, try to equalize asset divisions throughout these “buckets.”  If there is an offset, accounting for taxes may be important, which can be tricky, especially when some funds won’t be accessed until retirement. 

As always, being informed and working with a trusted financial professional who is certified in divorce financial analysis can help make an already daunting and stressful process a little less complicated.

Until next month, be wealthy and wise!

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