By: James Brewer, MBA, CRPC®, CFP®, CDFA®
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 in turn can reduce your stress level. Your financial situation can be viewed in 4 different 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 asset; this means that in order to access the money, you have to 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 that Gus keeps his retirement assets (valued at hundred thousand dollars), and she would take the money-market account (also valued at $100,000). Gus agreed because it looks 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%, then he would end up with only $75,000 versus the hundred thousand dollars that 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 is going to be sold: consider who is going to 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 that the other spouse has no financial obligation for a joint debt? Absolutely not! If the spouse who 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 are on the cards? Does the non-debtor spouse have to charge privileges on the card? Should you call and have charging privileges frozen?
Often 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 that you keep returns for at least the last 5 years; in addition, you may need records to calculate the cost basis for any assets that 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 maintenance 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 has residential custody of the children. In the state of Illinois, the calculation of child support is done by a state-mandated formula. As of July 1, 2017, child support will be based on the number of overnights the children spend with a parent and expenses made (school, after school program, clothes, etc. 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 some 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 can significantly decrease. Unless you change your occupation for one with a higher paycheck, you will have the same amount of income but with an increase of expenses. Where there was once one house there are now two, which need to sustain. A good time to obtain a sense of where you are financially, is when you are considering a divorce. Divorcing individuals need 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. CERTIFIED FINANCIAL PLANNER™ professional’s job is to give you an understanding of your financial needs. The CFP® professional can help you with budgeting, investing, retirement, and other financial planning issues during this very 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 voiced in this material are for general information only and are 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 that you discuss your specific situation with a qualified tax or legal advisor.