Dear Carrie,
I got divorced last year and I get both alimony and alimony from my ex. Can I use this money to fund an IRA?
-A reader
Dear Reader,
I am pleased that you are interested in financing an IRA, but unfortunately you cannot use child support or child benefit for it under current tax law. IRA contributions can only be paid from earned (taxable) income. Child support was never taxable. While alimony was previously considered taxable income, this changed with the Tax Cuts and Jobs Act of 2017. If the divorce treaty was signed after December 31, 2018, alimony is not taxable for either the payer or the recipient.
So the good news is that you don’t have to pay any income tax on your alimony. On the other hand, you cannot use it to contribute to a tax-deferred IRA. But that doesn’t mean you can’t invest this money wisely.
Start with your goals
Before investing, think about three things: what you are investing for, how much risk you can afford, and how much time you have to invest your money. Then take a close look at your current financial situation. Do you have an emergency fund? Are you getting the full match in your 401 (k)? Are there gaps in your insurance needs? Do you have credit card debt? These factors can help you determine how much and where to invest.
Discover your investment opportunities
Child support should be used specifically for the child’s well-being. Even if you can’t use child support and alimony to fund an IRA, there are several other smart ways you can invest them. Some are taxable and some offer tax benefits similar to an IRA. Here are a few options to consider:
- Brokerage account—A brokerage account has no tax deferral, but there are no contribution or payout limits. You can use a regular brokerage account or set up a custody brokerage account under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) to invest for a variety of purposes. Investing in a broad-based mutual fund, exchange traded fund (ETF), or fractional stock is one way to get started.
- Health Savings Account (HSA)– An HSA is available if you have a qualified high-deductible health insurance plan (with a minimum deductible of currently $ 1,400 for individuals and $ 2,800 for families). You may only think of it as a way to save on medical costs, but there is more to it than that. Contributions are federal and most state tax deductible, and income grows tax protected. Also, there is no tax on withdrawals when used for qualifying medical expenses. In addition, the money rolls in year after year and you can usually invest it much like you would with an IRA. It can be a great way to meet your family’s healthcare costs, as well as save and invest for the future. Contribution limits for 2021 are $ 3,600 for an individual and $ 7,200 for a family.
- 529 college savings plan– A 529 is an excellent way to save for your kids’ college and enjoy some tax breaks too. Some states offer tax deductions or credits for contributions that keep revenue growing without tax – and you don’t pay federal income tax (or state income tax in most states) on withdrawals as long as the money is used for skilled education expenses. This includes a variety of post-secondary options, as well as up to $ 10,000 per year for elementary or high school education.
Don’t forget about the child tax credit
Since these are tax benefits, here’s a reminder of the Child Tax Credit and the Child and Care Credit. Every tax credit has been expanded for this year by the American Rescue Plan Act – and each can go a long way in reducing your tax liability and potentially increasing the amount of money you can save and invest.
Now back to that IRA
They do not say whether you have earned income in addition to child support and child support, but if so, you are trying to find something for an annual IRA contribution. It can be a challenge, but even a small amount that is saved consistently can make a huge difference to your future. Your best bet? Do it automatically! For that extra boost, see if you qualify for Saver’s Credit, which is a special tax break for low- to middle-income taxpayers looking to save for retirement.
As you can see, there are several ways you can use your money for yourself and your child. Consult with an accountant or financial advisor to make sure you are making the most of all options and refining your strategy.
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Do you have a personal finance question? Email us at [email protected]. Carrie cannot answer questions directly, but your topic may be considered for a future article. For questions about the Schwab account and general inquiries, Contact Schwab.
Disclosure:The Charles Schwab Foundation is a 501 (c) (3) not-for-profit, private foundation that is not owned by Charles Schwab & Co., Inc. or its parent company, the Charles Schwab Corporation. The information provided here is for general informational purposes only and should not be viewed as an individual recommendation or personalized investment advice. The investment strategies outlined here may not be suitable for everyone. Every investor must review an investment strategy for his or her particular situation before making an investment decision. All expressions of opinion are subject to change without notice in response to changing market conditions. The third-party information contained herein is obtained from sources believed to be reliable. However, no guarantee can be given for their correctness, completeness or reliability. COPYRIGHT 2021 CHARLES SCHWAB & CO., INC. MEMBER SIPC. (# 0721-1CU9)