Navigating the financial landscape after a divorce can be daunting, especially when it comes to taxes. The shift from joint to individual filing, changes in income sources, and the division of assets all have significant tax implications. Fortunately, with careful planning and a solid understanding of available strategies, you can minimize your tax burden and secure your financial future. This blog post will explore several key tax savings strategies tailored for divorcees, covering everything from determining your correct filing status to leveraging retirement account distributions and maximizing health insurance premium tax credits. Let's delve into these essential tips to help you make informed decisions and optimize your post-divorce financial situation.
Good For: Divorcees with minor children or children in college.
Your tax filing status can significantly influence the amount of tax deductions you are eligible for, and the rate of income tax applied against your income. Filing status is determined as of the end of the year. If you divorce mid-year, you will file as either single or head of household for that year. Head of household filing status offers higher deductions and lower tax rates on equivalent income to that of single filers.
To qualify for head of household, you must provide over one-half of the cost of maintaining the household for you and a qualifying dependent (such as a child). Note that your filing status is not contingent on claiming a child as a dependent on the return. While the divorce agreement may stipulate a different arrangement for claiming children for tax purposes, the head of household filing status is generally granted to the person the child spent the greatest number of nights with.
Both parents may not claim head of household as a filing status. A qualifying child for head of household filing status is a child you are qualified to claim as a dependent (again, regardless of whether you do under your divorce agreement). Generally, unless disabled, the child must be under the age of 19, or 24 if a full-time student.
Good For: Divorcees who are retired or otherwise need to supplement their income with withdrawals from their investments and multiple account types to choose from.
If you are not working and need to cover your expenses from your investments, or supplement your other income sources with withdrawals, consider how much you need to withdraw and what accounts to appropriately withdraw from to cover your living needs.
One important change for divorces in recent years is how maintenance and alimony are taxed. For divorces that occur after December 31, 2018, alimony is not taxable as income to the recipient, and nondeductible for the payor spouse. As a result, various “low income” tax planning strategies are available for those that receive alimony and child support to cover significant portions of living expenses.
Creating the most tax-efficient income stream is available to those that have diversity among the types of accounts that they own. For example, if you have an IRA or 401(k) with pre-tax dollars and a sizeable cash balance or a non-retirement brokerage account. Taking funds out of a pre-tax account may come with a higher tax cost as every dollar distributed from the account is taxed as “ordinary income”.
Conversely, withdrawals from a Roth account or brokerage account are either free from income taxes or the resulting tax is far lower and at more favorable “capital” tax rates. As such, it may be beneficial to carefully structure a plan for withdrawals that includes taking funds out of both pre-tax accounts and those that are more favorable. For example, taking funds out of pre-tax accounts until you reach the limit of a lower tax bracket, such as 12%. You may then take the difference from more tax favorable accounts such as your Roth or brokerage account. The result is often a lower tax bill over multiple years rather than taking all the funds from a pre-tax account.
However, it is important to note that you may be subject to an early withdrawal tax penalty of 10% from pre-tax accounts if you are not yet 59.5. While there are strategies to avoid this penalty, implementing them can be complex and you should coordinate their implementation with a tax or financial planning professional.
As noted above, taking money out of retirement accounts such as 401(k)s or IRAs may cost you more if you are not yet 59.5. Specifically, the penalty for such early distributions from these accounts is an extra 10%. It is common, however, for many divorcees to have either short-term or ongoing expense needs following a divorce that necessitates tapping into such plans at a “pre-retirement” age. The good news is that if you find yourself in this situation, there are options available to avoid the extra penalty assessed on such distributions.
Withdrawing Funds from a Workplace Plan as Part of a Qualified Domestic Relations Order (“QDRO”)
Good For: Divorcees younger than 59.5 who have larger one-time cash needs, such as paying off debts or making a down payment, immediately following their divorce.
When workplace retirement plans, such as a 401(k), are divided as part of a divorce the court must first approve a Domestic Relations Order (DRO). An attorney part of the divorce typically drafts these orders to submit to the court. Once approved by the court, the order is then sent to the plan administrator, who also approves it making it qualified, or a “Qualified Domestic Relations Order” (QDRO). Following the approval process the plan is now ready to divide the assets and pay the portion to the “alternate payee” ex-spouse.
If you are the recipient of a QDRO, you have two options. First, the balance can be rolled into an account in your name, typically to an IRA. The benefit of this option is that the transfer is free from both income taxes and penalties. Although taxes must still be paid on any pre-tax balance later when funds are ultimately distributed from your new account, the tax liability is deferred - often for many years.
The second option is to receive a distribution from the account directly. Any distribution from the plan to you directly will be subject to income taxes. However, the 10% penalty that typically applies for a pre-59.5 withdrawal is waived when it occurs pursuant to a QDRO.
For example, if you receive $200,000 of a 401(k) balance under your divorce agreement you could request $50,000 of this amount be sent to you directly while rolling $150,000 into an IRA in your name. You would be responsible for paying taxes on the $50,000 distribution immediately, but the $5,000 associated penalty for withdrawing from a retirement account before 59.5 is waived. Conversely, if you take $50,000 from an IRA or another non-qualified pre-tax account you would also have to pay the $5,000 penalty. This strategy is only available for workplace plans such as 401(k)s.
Importantly, this distribution must occur before the assets are moved into your name to avoid the penalty. As such, a limited window exists for this strategy as divorcees seek to finalize their divorce by cleanly separating their assets. These distributions are most useful in cases where a one-time or limited term need for cash exists with no better options. Such examples may include paying off certain debts or covering a down payment on a home.
Penalty Free Distributions from IRAs
Good For: Divorcees younger than 59.5 who have an ongoing expected need for withdrawals from an IRA to cover living expenses after their divorce.
Like workplace plans, taking money out of an IRA before you reach 59.5 is also generally subject to a 10% penalty. However, there are several specific exceptions. One of the most utilized exceptions by divorcees is for “substantially equal periodic payments”.
Alimony, child support, and other income sources may not be sufficient to cover your living expenses. If funds are tied up in IRAs, you may have no other options to help supplement your income needs. If you are younger than 59.5, you may feel stuck and feel you cannot avoid extra penalties on top of the tax bill that comes with taking money out of an IRA.
One useful solution exists in setting up your IRA to pay out “substantially equal periodic payments”. Essentially, this strategy involves setting up the account to distribute a certain amount from your IRA in regular intervals such as monthly or annually. Very specific rules apply to the method of calculating the amount that must be distributed. Given the complexity of these calculations, you will need to set up this plan appropriately with a tax or financial professional experienced in them.
Consider the following example:
Sandra is currently 52 and recently divorced. She received $2 million in the divorce settlement in her ex-husband’s IRA account. She also received cash but has utilized most of this by paying off certain debts and the remaining balance of her mortgage. She receives $5,000 per month in alimony and has a part-time job earning $2,000 per month. However, she estimates that she spends $8,000 per month and therefore needs to take $1,000 each month from the IRA account, net of taxes. However, as she is not yet 59.5, she will be subject to a 10% penalty for any amount withdrawn from the IRA.
Working with her financial planner, together they set up a plan for substantially equal periodic payments from her IRA. First, they move $250,000 of the $2 million IRA to a separate account designated for this purpose. Using one of the calculation methods available, they establish a fixed monthly distribution of $1,250 per month. After withholding 20% taxes, $1,000 is deposited into Sandra’s checking account each month to supplement her income. The amounts withdrawn from the IRA are subject to income taxes, but she saves the $1,500 tax penalty that would otherwise apply each year.
There is one critical factor to understand with setting up this strategy. Distributions established must continue until you reach 59.5 or five years, whichever comes later. If the plan is modified or distributions cease too early there is a significant cost. You must pay all the penalties saved since the plan was implemented, including interest.
Substantially equal period payments are a useful tool for divorcees who have an ongoing need to supplement their income from a retirement plan before 59.5. However, such payments must continue for a period of years without modification. As such, careful consideration should be given to both current and expected future income needs.
Good For: Divorcees in a lower income tax bracket following their divorce with large pre-tax investments such as an IRA or 401(k).
Divorce is a significant change in tax circumstances. This is particularly true in cases where one spouse in the marriage has a high income, and the other spouse has significantly less or no income from employment. In these cases, the spouse with lower income may find themselves in a significantly lower tax bracket than when they were married. It is important to repeat again that for divorces that are finalized after 2018 alimony is no longer included in the income of the recipient, or deductible to the payor ex-spouse. Even if you receive significant alimony or child support, this may not cause you to be in a higher tax bracket.
If these circumstances apply to you, you should review the makeup of your long-term retirement assets. If you have a significant amount in an account that will ultimately be taxed when distributions occur, Roth conversions may be an appropriate opportunity to explore.
A Roth conversion is the process of proactively moving money from a traditional “pre-tax” IRA, 401(k), or other pre-tax account to a Roth IRA. The amount converted from pre-tax to Roth is immediately included in income and subject to income tax (with no penalties). However, once the money is in a Roth IRA, it can grow tax free and not be subject to taxation later with the funds are withdrawn.
Why may this strategy be advantageous? For one, when alimony and/or child support ends in the future you may have to turn to your retirement funds to begin covering your living needs. If you only have pre-tax accounts to pull money from, you will have no flexibility in controlling your taxable income. Creating different tax “buckets” to pull money from allows you to be far more strategic in controlling your bracket and taxable income in the future. See “Need to Supplement Income from Retirement Assets? Carefully Plan Your Strategy” above for more details.
Second, even if you have investment accounts other than those that are pre-tax, this strategy may still make sense. When you reach a certain age, for most either 73 or 75, you will have to withdraw and pay tax on a certain amount of your pre-tax accounts. These are called “required minimum distributions”. Such mandatory distributions are calculated based on the balance in the pre-tax account at the end of the preceding year. The higher the account balance, the higher the required taxable distribution. As Roth IRAs are not subject to mandatory distributions, choosing to convert amounts to Roth today reduces the amount you will be forced to withdraw in the future.
The essential idea with Roth conversions is that you intentionally pay taxes at a lesser rate today to avoid paying a higher income tax rate in the future.
Good For: Divorcees with low taxable income following their divorce with no group options for health insurance.
Health insurance planning is a significant topic that applies to almost everyone who experiences a divorce. The choice for the best health coverage largely depends on whether you are still working, your current health status, and financial situation. Although this section discusses certain tax benefits available for health insurance coverage, taxes may not be the most important factor in selecting the right coverage. You should always review your unique situation with a financial or health insurance professional.
Many divorcees may not have group options available, either through work or through continuation coverage offered under an ex-spouse’s employer. In these cases, the Health Insurance Marketplace® is one alternative for coverage often selected. Plans on the marketplace follow a category system based on what dollars the plan pays versus the enrollee. These categories are Gold (highest plan coverage, highest premium cost), Silver (moderate plan coverage) and Bronze (lowest plan coverage, lowest premium cost). One of the benefits of coverage under the Health Insurance Marketplace® is the availability of the premium tax credit. The premium tax credit is a tax credit offered by the federal government that can be used to lower your monthly insurance premium.
The most influential elements of the amount of the premium tax credit you may be eligible for are age, household size, and gross income. Generally, the credit is available for those who have incomes of at least 100% of the federal poverty guidelines for your household size. For example, in 2025, the poverty guideline income for a household size of two is $21,150. Incomes less than 100% of such guideline disqualify one for a premium tax credit as the government presumes assistance is available under your state’s Medicaid system.
If you qualify, the available credit is calculated by determining the cost of your health insurance (including those who require coverage in your household) and comparing that cost to a certain percentage of your income. This percentage, referred to as your “contribution amount” is the expected amount of your income you must apply toward your premium cost. This percentage ranges from 0% to 8.5%, depending on your total income as a percentage of the poverty guidelines. Your expected contribution is then compared to the silver plan with the second lowest cost (the “benchmark” plan). If your cost of this benchmark plan is higher than your expected contribution amount, the difference is the premium tax credit you are eligible for.
Example:
Kathleen, age 47, lives in Missouri and is recently divorced and maintains the household for her son, 17, and daughter, 15. All three require health insurance and have no alternatives available through group coverage. Kathleen is currently receiving $8,000 per month between child support and maintenance from her ex-husband, which covers all their current living needs. Besides the child support and maintenance, the only taxable income to Kathleen is $105,000 of dividends and interest her retirement investments generate each year.
With the assistance of her financial planner, Kathleen enrolls in health coverage through the Health Insurance Marketplace®. They input her expected household income of $105,000. They do not include her alimony or child support as these amounts are not taxable or included in the gross income amount requested.
In 2025, the federal poverty guideline for a household size of three is $26,650. Kathleen’s income is 394% of the federal poverty guideline, and based on a table provided by the IRS learns that her expected contribution amount toward her family’s health insurance premium is 8.35%, or about $8,800 per year. In reviewing the insurance plan options available to her family, Kathleen notes that the second lowest cost silver plan for her family of three has a cost of $14,800. As such, Kathleen is eligible to receive a premium tax credit valued at $6,000 per year!
Would it surprise you if we said that Kathleen’s portfolio is valued at around $5 million, with $1.5 million in an IRA and $3.5 million in a brokerage account? The reality is that this is a realistic set of circumstances. The premium tax credit is not directly related to the amount of assets one has – only certain types of income.
Exploring the availability of tax credits to help offset the cost of insurance premiums is one of the most common strategies worth exploring for divorcees. As the example illustrates, the dollar benefits of the credits can be substantial in some cases. Once more, child support and alimony received for divorces finalized after January 1, 2019 are not included in the income used to qualify. Ultimately, this creates a common circumstance where divorcees are eligible for such credits while still maintaining high asset balances and receiving enough spousal support to cover other everyday expenses.
Good For: Everyone.
Our final recommendation is more general. All recent divorcees should make it a point to meet with either their tax advisor or financial planning professional to review their current tax situation. While our discussion over topics above are intended to offer certain tax reduction ideas, they may not all work together. For instance, if you implement a Roth conversation strategy, that will also raise your income to calculate your eligibility for premium tax credits. As such, the balance of such strategies must be considered and applied against your own goals, facts, and circumstances.
Divorce inevitably brings about significant financial adjustments, and understanding the tax implications is crucial for establishing a stable post-divorce life. From carefully selecting your filing status to strategically managing retirement account withdrawals and exploring health insurance premium tax credits, the strategies outlined in this post offer valuable insights into navigating the complexities of taxes after divorce. However, it's essential to remember that every divorce is unique, and the best approach will depend on your specific circumstances. The interplay between different strategies, such as Roth conversions and premium tax credits, highlights the need for a comprehensive financial plan. Therefore, we strongly recommend consulting with qualified tax and financial planning professionals. Their expertise will ensure that you implement the most effective strategies tailored to your individual needs, helping you achieve financial clarity and security as you embark on this new chapter.
Prosperity Planning is neither an attorney nor an accountant, and no portion of the content should be interpreted as legal, accounting or tax advice. Be sure to consult with a tax professional before implementing any investment strategy. Investment advice, financial planning, and retirement plan services are provided by Prosperity Planning, Inc., an SEC registered investment advisor. The information contained herein, including but not limited to research, market valuations, calculations, estimates and other material obtained from these sources are believed to be reliable. However, Prosperity Planning, Inc. does not warrant its accuracy or completeness. The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or to participate in any trading strategy. If an offer of securities is made, it will be under a definitive investment management agreement prepared on behalf of Prosperity which contains material information not contained herein and which supersedes this information in its entirety. Any investment involves significant risk, including a complete loss of capital and conflicts of interest. The applicable definitive investment management agreement and Form ADV Part 2A will contain a more thorough discussion of risk and conflict, which should be carefully reviewed before making any investment decision.