Divorce and money can be a combustible mix. Especially if money was one of the drivers of a divorce, working out who gets what is delicate. Even more challenging can be adjusting to a new and often more modest lifestyle after divorce.
Yet there are steps you can take to minimize financial problems in and after divorce -- and to maximize the likelihood each spouse can achieve their financial goals.
Step 1: Get professional help
At a minimum, both parties should have legal representation from an experienced family law attorney. Choosing an attorney who is a Board Certified Family Law Specialist can provide added assurance that your attorney has the required knowledge and experience in this complex area of the law.
Hiring an attorney does not necessarily mean you will go to court. In fact, a relatively small percentage of separating couples must have a court make decisions on property, support, and child-related issues. You and your lawyers will likely work out a negotiated agreement, perhaps with an independent mediator to help resolve the toughest issues.
We believe each side should also have a financial planner who understands your situation, understands divorce and can help you and your attorney assess financial issues and trade-offs. Preferably, your advisor should be a Certified Divorce Financial Analyst® professional, who had to demonstrate knowledge of divorce financial issues to earn the certification. He/she should also be a CFP® professional, which is the most widely accepted credential for comprehensive financial planning.
Step 2: Understand your finances before divorce
Before you decide to divorce, it is critical to understand your financial condition. You may still decide to divorce – regardless of what you find -- but you’ll be moving forward with eyes open.
Especially if you do not have primary responsibility for your family’s finances, try to inventory what you have without “tipping off” your spouse. This will reduce the chances that your spouse could successfully obscure the family financial situation by hiding assets and income or misrepresenting liabilities and expenses. Misrepresentation of financial information is prohibited by divorce-related rules and laws, but it can happen.
Assets and liabilities. Determine what assets you own and their value, as well as what debts you owe. Make copies of documents and keep them in a safe place. Below is a list of major categories of assets and debts to look for, but there may be others that are applicable to you:
- Brokerage accounts, retirement accounts, and bank accounts
- Value of real estate: primary and vacation or rental home(s)
- Mortgage and other debts
- Projected value of any pensions, even if they do not pay out for years
- Social Security benefits
- “Permanent” insurance policies with cash value
- Term life insurance policies; they have no financial value but can be useful in negotiations, for example, to protect a spouse recipient of alimony in the event of the payee’s premature death
- Long-term care insurance policies
- Deferred compensation plans
- Private investments; determining the value can be challenging
- Business interests
- Expected inheritances
- Anticipated tax refunds or tax due
Income and expenses. Determine sources of income you and your spouse have, as well as your recent and anticipated expenses:
- Anticipated sources of income for each spouse over the next few years
- Anticipated expenses for each spouse over the next few years
- Child-related expenses (including private school and college)
Keep a copy of any budgets you’ve followed in the past. Make an extra copy of your tax returns for the past 5 years and provide them to your advisor and attorney.
Step 3: Prioritize your money asks – for the property split, alimony and child support
You will not get everything you want – financial or non-financial. Your attorney can usually help set reasonable expectations of the range of possible outcomes. Your attorney and financial advisor can also help you negotiate for the assets that are most important to you. A few examples:
- You may need liquidity (cash in bank or brokerage accounts) more than you need retirement plan savings, especially if you are young with time to save but without a strong current income.
- You may need alimony for a few years only if you have income or see a path toward it.
- You may feel strongly about controlling the 529 college savings plan accounts for the benefit of your children.
- You may want to trade an ownership interest in the business your spouse runs if he/she is critical to its future value – assuming you receive enough to compensate for what you gave up.
Step 4: Understand your spouse’s financial priorities
Your spouse may have different wants or needs from yours – which means a “win-win” may exist. A classic example: perhaps only one of you wants the house. It’s never quite that easy, because owning the house usually means there is a greater cash need than if you downsized to a rental apartment. But it’s a lot easier if one of you is happy to give up the house.
You can surely find some aspects of your negotiation where your objectives do not conflict with your spouse’s.
Step 5: Remember the impact of taxes
The 2018 tax law eliminated a key tax benefit for many divorces: the ability for the paying spouse to deduct alimony, shifting the tax burden to the payee, who is typically in a lower tax bracket. The net tax savings was meaningful for many couples.
But the change in the tax law doesn’t mean tax is irrelevant in the negotiation. Far from it.
- A simple example: a brokerage account is worth more than a traditional retirement account, because when you withdraw money from a retirement account, you owe ordinary tax on the entire amount. By contrast, you will only owe tax on annual income and gains in a brokerage account, and typically that income is taxable at lower rates.
- Another example: a second home with a gain is worth less than a primary home because the first $250,000 of gain on a primary home (for a single tax filer) is free from capital gains tax.
- Consider the tax benefits associated with children before you negotiate custody and child support.
Before agreeing to financial terms of the divorce, have your CDFA® professional calculate the pre-tax and after-tax value for each party – and focus on the after-tax value. It is most common that each side will receive 50%, although it is not guaranteed. Divorce in most states is equitable, not equal.
Step 6: After agreeing on divorce terms, work on what is time-sensitive but – if possible -- avoid big money decisions for at least 3-6 months
- While emotions are highest, try to avoid major decisions that are not time-sensitive. One example is selling your home (assuming you are keeping the family home) or buying a new home (if your ex-spouse is keeping your residence). Often the spouse with custody prefers a permanent housing situation, so delaying housing decisions is not always optimal.
- Another example is making major investing decisions – for example, whether to own risky assets like stock or conservative assets like bonds.
- It may also be difficult to predict your income and expenses, which suggests waiting for a period post-divorce to make any major decisions.
In the meantime, work on important but more “mechanical” money tasks
- Make sure bank accounts, brokerage accounts, 529 college savings accounts, etc. have up-to-date account ownership and addresses.
- Update your last will, beneficiary designations, powers of attorney, advanced health care directive and trust (if you have one).
- If your spouse waived the right to receive your retirement assets at your death, make sure the appropriate waivers are on file with the retirement plan administrator during the post-separation, pre-divorce period.
- Update insurance policies.
- Consider hiring an accounting firm to prepare your taxes, if you do not already have one.
Thank you to Julie Woodmansee of Woodmansee & Szombatfalvy, in Durham, NC, for reviewing and improving this white paper. Julie is a North Carolina Board Certified Legal Specialist in Family Law.
This article is not intended to provide tax, legal, accounting, financial, or professional advice. Readers should seek advice from qualified professionals who can review their specific circumstances. Old Peak Finance endeavors to provide information that is accurate and current. However, we cannot guarantee that this information has not been outdated or otherwise rendered incorrect by new research, legislation, or other changes. Old Peak Finance has no liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on our website.