If you are recently divorced, you may be experiencing a lot of ‘firsts’. For example, you may have to do your own taxes for the first time and feel like a deer in headlights, frozen and overwhelmed by the facts and figures you are sorting through. Or, maybe you have to set up a budget for the first time and try and determine where your money should go, how much money you should keep in savings, how you should invest in the market, and more. Managing, monitoring, and learning about investments likely feels like a full-time job—and one you aren’t getting paid for.
In this post, we help you sort through one aspect of your divorce related to your investments and how you might be able to reduce your capital gains tax by considering some different investment strategies. Please note that this post does not serve as tax or investment advice and you should always consult with your team of professionals for individual guidance based on your unique situation.
What to consider
The most suitable investment management strategies take all of an individual’s financial considerations into account, including taxes. There is no question that post-divorce financial life is drastically different and you might not have a grasp on the most effective ways to invest or file your taxes. Working with a professional, especially if you have experienced a lot of change, will save you time, money, and headaches.
It is overwhelming enough to address the issues previously mentioned and therefore quite easy to overlook that you may be paying substantially more in capital gains tax than you could be. Some post-divorce individuals may qualify for 0% capital gains tax when instead many people may be unknowingly paying 15% on their gains instead because they aren’t working with a financial professional who can provide guidance on money-saving strategies like this and more.
The following individuals are more likely to qualify to take advantage of 0% capital gains rates on their investments:
- Post Divorce individuals with annual employment wages between $0-$60,000.
- Some of these individuals might also be receiving tax-free maintenance on top of their own personal wages. For divorces that were finalized before or in 2018, maintenance is usually taxable income (unless otherwise specified in their agreement) in which case their employment income and taxable maintenance would need to fall into this range. All divorces finalized after 2018 have tax-free maintenance and the payor does not receive a deduction.
- Individuals who received taxable investments from divorce asset division or maintenance lump sum payout.
- This type of payout creates ongoing taxable gains, especially if it is invested. If it isn’t invested, you might be missing out on key opportunities to grow your wealth and meet future life goals.
- Individuals who are not working with an experienced financial advisor who specializes in divorce circumstances.
- Many individuals qualify for 0% capital gains taxes but don’t know this is the case because they feel confident enough in their ability to manage their finances on their own and want to try and save on expenses or they are working with professionals that do not incorporate tax planning into their investment strategies and probably don’t know the client’s overall situation that well.
- Many individuals qualify for 0% capital gains taxes but don’t know this is the case because they feel confident enough in their ability to manage their finances on their own and want to try and save on expenses or they are working with professionals that do not incorporate tax planning into their investment strategies and probably don’t know the client’s overall situation that well.
Let’s break it down
We know taxes and investments are a confusing topic, especially if you weren’t managing your finances in your previous marriage. Let’s look at an example to illustrate what kinds of savings are possible. With a little tax and investment planning, you may be able to qualify for the 0% capital gains tax rate that is available to taxpayers in the 10%-12% marginal tax brackets.
Mary works as an executive assistant with an annual salary of $50,000. After her divorce, she begins to receive $4,000 per month in tax-free spousal support. Among the assets divided in her divorce, she was awarded a $300,000 investment account that holds stocks, bonds, and mutual funds. Those investments are managed by the same advisor who worked with her ex-spouse when they were married and she didn’t have much communication with this professional.
The account is well balanced, has been growing steadily, and produces $9,000 (3%) in annual income. This additional income generated from the qualified dividends and long-term capital gains has pushed Mary into the 22% tax bracket from the 12% bracket that her salary aligns with. Therefore, Mary is paying $1,350 in taxes associated with these gains because she has been bumped into a higher tax bracket.
What if there was a way to pay $0 in taxes and still have the account grow? Is it possible for you to pay 15% less in taxes on your investments? There are numerous ways to invest which all have various tax implications. Do you know which one is the best for you?
Ask Yourself These Four Questions
Now that you have a better idea of how your investment strategies can affect your taxes, the following questions can help you determine what to do next. If you answer ‘no’ or “unsure” to any of these questions, you should talk to your financial professional:
- What marginal income tax bracket are you in?
- How much are your investments producing in taxable income?
- Is your investment income pushing you into a higher tax bracket and therefore substantially increasing the taxes you owe?
If you answered “no” or “unsure” to any of these questions, you should consult with your financial professional. It can be overwhelming to manage all your finances and understand all the changes you have experienced post-divorce. Your financial professional can help you understand your short-term financial choices and help you achieve your long-term goals.