Financial planning for divorced people is more important than you may think! When contemplating divorce, many people put themselves under undue stress, as they worry about their financial well-being.
Much of that stress is due to the fear of the unknown before, during, and after divorce. It is important to realistically focus on your financial situation, since doing so will give you a sense of control over your life, which can reduce your stress level. Your financial situation can be viewed in four categories: assets, liabilities, income, and expenses.
Assessing financial assets in divorce
Financial assets include cash, savings accounts, checking accounts, certificates of deposit, money-market accounts, stocks, bonds, real estate investment trusts (REIT), mutual funds, and savings bonds.
When considering divorce, these assets may be more important to the non-working or lower-income-earning spouse, who may need to use them to cover some of his or her living expenses.
All assets do not have the same tax consequences! Retirement assets are generally before tax assets, which means that to access the money, you pay income tax on any distributions you receive. In some cases, you may also have to pay a penalty on the distribution, in addition to the income tax.
For example, Mary suggested Gus keep his retirement assets (valued at one hundred thousand dollars), and she would take the money-market account (also valued at $100,000). Gus agreed, because it looked like an equal division of the assets. However, when Gus retires in a couple of years, he will pay taxes on the distributions. So if Gus pays a tax or rate of 25%, he would end up with only $75,000 versus the hundred thousand dollars Mary received.
It is important that you determine how defined-benefit plans, such as pensions, will be divided between you and your spouse. This is generally spelled out as a percentage of the retirement benefit at the time of the divorce. If not, and the employed/retired spouse dies, this would leave you, the surviving spouse, without money you had counted on.
The assets discussed in this blog are by no means exhaustive. You and your spouse may have other assets to value, in addition to these. That’s why it’s important to get professional support.
Splitting the real estate after divorce
Real estate includes your marital house and any other houses, vacation properties, timeshares, and rental properties, such as commercial and residential, as well as any business property. If you are like most people, you call the house a home. The term home typically is full of emotional memories and is a difficult asset to assess. If the property will go on the market for sale, consider who will pay the expenses until the property is sold? How will the proceeds (or debts, if the property sells for less than the amount left on the mortgage) be divided?
At divorce, debts do not part
Generally, the person who keeps the property will be expected to pay the mortgage or debt related to that property. Does this mean the other spouse has no financial obligation for a joint debt? Absolutely not. If the spouse assumes responsibility for the property and pays the existing mortgage, both spouses will still be obligated to pay the debt. The divorce decree cannot terminate your financial obligation to your creditor.
Credit cards are another problem area. Do you know the balance on the cards? Whose name the cards are in? Does the non-debtor spouse have to charge privileges on the card? Should you call and have charging privileges frozen?
Many times, one spouse leaves the taxes up to the other in the division of household labor. Each spouse should keep copies of joint tax returns. We recommend you keep returns for at least 5 years, and you may need records to calculate the cost basis for any assets you keep. It’s important when negotiating a settlement that you understand the tax implications. If you are filing jointly, one of you (if not both) will be filing as single and paying a higher tax rate. If there are dependent children, the spouse who is the custodial parent will likely benefit from a head of household filing status.
Child support and spousal support, and who pays the taxes?
Child support can be confused with spousal support aka alimony. If you receive alimony, you will be taxed on what you receive. If you are the spouse paying the spousal support, you will see a reduction in your income. Child support is not taxable to the spouse who was the custodial spouse. In the state of Illinois, the calculation of child support is done by a state-mandated formula. There is no negotiation. Spousal support is negotiable, and the case must be made for the spouse claiming the need. Hopefully, that is settled by negotiation, rather than going to court to make that case. Beyond the scope of this blog, there are potential penalties to be faced by the payor when child support is veiled as spousal support to benefit from lower taxes.
Who should you turn to for analyzing your financial situation before your divorce?
During and after divorce, many people report their standard of living sometimes significantly decreases. Unless you change your occupation for one with a higher paycheck, you will have the same amount of income, but with an increase in expenses. Where there was once one house, there are now two, which need to sustain. A good time to get a sense of where you are financially is when you are considering a divorce. Divorcing individuals should seek sound financial advice to ensure the settlement is fair to both parties. After a couple is divorced, they will benefit from this assistance in adjusting to the new circumstances and planning for a secure future.
A Certified Divorce Financial Analyst® (CDFA™) is a professional that can take the offer on the table and project out 5, 10, 20 years to show you what your financial circumstances will look like if you sign the agreement. A CERTIFIED FINANCIAL PLANNER™ (CFP) professional’s job is to provide clients with an understanding of your financial needs. The CFP® professional can help you with budgeting, investing, retirement, and other financial planning issues during this important life transition.
Considering a divorce? James Brewer, President of Envision Wealth, is both a CDFA™ and a CFP® professional. Contact us to learn about our compassionate approach to helping clarify your financial consequences during this life-changing time.
The opinions in this material are for general information only. This information is not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest you discuss your specific situation with a qualified tax or legal advisor.