Financial Planning through the Process of Divorce

When a married couple decides to permanently part ways, their first step is often to consult a lawyer–or perhaps an arbitrator or mediator–to help them navigate the process.  The business of separating one household into two, however, involves many financial decisions that those types of professionals may have less expertise and experience in analyzing than a financial adviser.  Without proper guidance, these financial decisions can leave one or both spouses feeling particularly anxious and vulnerable–especially if one spouse is a lower income earner and/or less financially literate in comparison to the other.  If you or someone you know is going through the process of divorce, encourage them to seek financial advice, and, in particular, to consider the following points.

Create a Financial Model for Your New Path.  As unsettling as it may be to reevaluate your financial plans and goals in light of the change created by divorce, doing so will likely ease the transition to your new path and decrease anxiety about your financial future.  Consider, for example, your plans for housing, work, and retirement and how they may be altered by the divorce.  Will you stay in your current home, move to a new location, downsize?  Will you need or want to re-enter the workforce after years spent at home?  Will this change in your family situation prompt you to retire later–or earlier?  Have a professional map out your assumptions for future income, assets, and expenses and determine whether your goals are reasonable and how they might be impacted by the details of your divorce settlement.

Income or Assets?  Both.  If you are the lower income spouse and will be receiving financial support from your ex-spouse now and/or in the future, make sure that you advocate for alimony and a share of your spouse’s assets.  If an attorney tries to simplify matters and asks whether you would like to pursue income or assets in the settlement, you should answer, “Both.”  Focusing on only one or the other may force you to 1) prematurely dip into savings that were intended to support your lifestyle in retirement, or 2) receive income (which may be dependent on your ex-spouse continuing to live and possibly to earn income at a comparable level) without any of the security of a retirement nest egg.  In negotiating a fair settlement, bear in mind too that alimony is taxable to the spouse receiving it and tax-deductible to the spouse paying it.

Compare Division of Assets on an After-Tax Basis.  If you are splitting up investment and retirement accounts, you must ensure that the proposed settlement is fair on an after-tax basis.  A taxable investment account may include unrealized capital gains on which you will owe tax when the investments are sold.  Funds in retirement accounts will face ordinary income tax upon withdrawal (though you will avoid the additional 10% penalty for early withdrawals before age 59 1/2 if the funds are withdrawn from an employer retirement plan in connection with a qualified domestic relations order, or QDRO).  By contrast, Roth IRAs and basic checking, savings, and money market accounts do not have any latent tax burdens, so their face value already reflects their after-tax value.

Consider the Financial Implications of Custody Decisions.  While custody decisions are obviously a very emotional issue, there are significant financial components to consider as well.  In addition to negotiating child support, couples should settle expectations for how college expenses will be divided, who can claim tax benefits for the children, etc.

Know the Potential Benefits and Liabilities Stemming from Your Marriage.  Make sure that you find out, document, and collect any benefits for which you may be eligible in connection with your marriage.  For example, if you were married for at least 10 years, you may be eligible for a Social Security benefit based on your spouse’s earnings record.  After age 62, you may be able to collect a spousal benefit, or after age 60, a widow’s benefit if your ex-spouse has passed away.  Similarly, if your ex-spouse is eligible for a pension, you may be entitled to a benefit in connection with it as well.  On the liability side, if, e.g., you suspect that your former spouse may have conducted tax fraud on a joint tax return, you may want to consider including language in your settlement that holds your ex-spouse responsible for any tax liabilities from past returns in order to avoid having to seek Innocent Spouse Relief with the IRS.

The process of divorce can be very overwhelming and stressful.  If you find yourself or close family or friends in that situation, you will likely need guidance on the legal side, of course, but also make sure that you seek help to understand and navigate the financial aspects of the process, so that you can feel more comfortable about your prospects for a sound financial future.