Spousal support is meant to help the receiving spouse get back on their feet, and compensate them for their unpaid labour during the relationship (e.g. for being a stay at home mom/dad while the other spouse pursued a career). It is typically paid on a monthly basis for several years or more.
There is another way to approach spousal support. Rather than pay monthly, the paying spouse can make a single payment equal to all the monthly payments combined. This is called lump-sum spousal support. For some, this has obvious appeal. It allows for a clean break between the spouses (no more e-transfers every month) and provides a degree of certainty and finality.
However, calculating lump-sum spousal support can be difficult. The spouses must first determine how much would be paid month to month, and for how long, requiring complex legal analysis. With that done, there are still two major pitfalls to look out for: tax consequences and the opportunity for investment. These pitfalls are the subject of this article.
With monthly spousal support, the paying spouse gets to deduct the payments from their taxes, and the recipient must claim what they receive as income. In contrast, lump-sum spousal support is paid after tax, meaning there is no deduction for the person paying, and no inclusion for the recipient. Without adjusting for this, there would be a significant windfall for the recipient.
Let’s say Bob makes $80,000 per year and pays $1,000 per month in spousal support to Susie. Because of his spousal support tax deduction, Bob will save $282 in taxes for every spousal support payment he makes. The true monthly cost to Bob for spousal support is therefore $718, not $1,000.
We can easily see the difference this makes in the long term. Say Bob is 50 now, and the spouses agree support will end when Bob retires at 65. That would be 15 years of monthly spousal support payments. If we do not adjust for taxes, 15 years of payments would be $180,000 in total. At an adjusted figure of $718 per month Bob would pay $129,240 total, a $50,000 difference.
Most lawyers will use professional software to calculate these tax consequences, so you likely won’t be able to make any adjustments on your own. For now, you should know that these tax consequences exist and will have to be accounted for if you are considering a lump-sum payment.
Opportunity for Investment
Money now is worth more than money later. If you receive money now, you can invest it and start receiving interest, which will compound over time. If you receive money later, you will have no opportunity to invest it until it is in your hands. This holds true for spousal support. An immediate lump- sum payment is worth more to the recipient, who can then invest the entire amount they receive (financial circumstances permitting), rather than wait many years to be paid out.
Let’s look at Bob and Susie again. Bob and Susie have now factored in the tax consequences, and agree that Bob should pay Susie $129,240. However, they have neglected to factor in Susie’s opportunity for investment.
If we assume Susie could earn a modest rate of return of 3% per year, we can determine how much she should be paid after this adjustment. The answer is $103,970, a $25,000 difference.
Looking back, we went from $180,000 before adjustments, to $103,970 after adjustments, essentially an $80,000 difference. As you can see, factoring in both the tax consequences and the opportunity for investment results is important.
If you are interested in paying spousal support upfront, rather than in monthly installments, it is strongly recommended that you consider hiring competent counsel to help you navigate through the process.
For more information regarding lump-sum spousal support or any other family law issue, please contact our Family Law Practice Group.
Lawyer | Family Law
This article is intended to be an overview of the law and is for informational purposes only. Readers are cautioned that this article does not constitute legal or professional advice and should not be relied on as such. Rather, readers should obtain specific legal advice in relation to the issues they are facing.