Last Updated: May 11, 2009
When it comes to life events, few can compare with divorce. With a divorce, your life gets turned upside down with many intended and unintended consequences. You have to worry about dividing property, pensions and retirement plans, and alimony and perhaps child support. And if you're a woman, there may be many more things to consider.
"The wife first should get expert legal advice and be willing to pay for it," FPA member, Carol Ann Wilson, CFP®, wrote recently in FPA's Journal of Financial Planning magazine. "Hiring a less expensive attorney may ultimately cost her more because she didn't get the best advice. She also should consult a financial planner who is knowledgeable in the financial and tax issues of divorce. Getting better information from a financial planner — before the divorce is final — concerning budgeting, cash flow, investing her assets, whether or not to sell the house, and so on will be of immeasurable help to her and her spouse."
FPA member, Leslie H. Beck, CFP®, CFA, of Beck Investment Management, LLC said there are several factors to consider before and after a divorce. It's a good idea to work with a financial planning team as you contemplate divorce, including a financial planner. Find a financial planner.
For her part, Wilson noted in her article that divorced women, especially older divorced women, are swelling the poverty rolls. "One major reason is that in creating a financially equitable settlement, judges and attorneys often forget that property is divided just once, but career assets continue to produce income regularly for years," she wrote.
Also, it's also important to note that divorce rules are specific to each state, but the tax consequences are usually federal, Beck said. Assets can be split in a divorce and there are usually not any gifting issues.
There may, however, be significant income tax issues. In addition, it's important to note that all assets are not the same. "A savings account is one figure, but the IRA, Keogh, 401(k) plans will be taxed as ordinary income and penalized 10 percent if the spouse withdraws the funds before age 59 ½," Beck said. "The retirement accounts must be considered at a discount, but judges do not always take the tax considerations into account. The consumer and their attorney need to make sure they understand all the ramifications before accepting any terms. QDROs may need to be set up and they are always more complicated than an IRA."
According to Beck, the QDRO, qualified domestic relation order, is a legal document prepared with the company that is paying the pension and creates or recognizes the existence of an alternate payee's right to receive, or assigns to an alternate payee the right to receive, all or a portion of the benefits payable with respect to a participant under a retirement plan. The consumer cannot prepare this alone. In California, for instance, it costs about $1,000 to $2,500 to prepare. It also seems to take at least six months to get done, she said. Learn more about QDROs.
According to Wilson's article, "Valuing assets in a defined-contribution plan is relatively simple, but the division and transference of those assets in a divorce can cause problems. Valuing assets in a defined-benefit plan is much more complicated, as is division of the property." There are two methods of division, "present value" and "deferred division."
Beck also noted that the house is usually a big issue because it is emotional and usually the largest asset. "If one spouse stays in the house they may have only their $250,000 exclusion for taxes on the gains, but with prior planning and inclusion in the settlement document, they may receive $500,000 exclusion," she noted. Wilson mentioned that, "In a traditional marriage, where the wife doesn't work or works little, a simple 50/50 splitting of assets can leave the woman broke. This is especially a problem when the woman receives the home as an asset, which won't produce needed income and which may have tax consequences." In addition, Wilson wrote that "The basis of a home or other financial assets is also often overlooked when dividing marital property."
Child support and alimony are another whole chapter, said Beck. For instance, California does not award alimony but Family Support. "For children it is fairly straightforward, the Family Support depends upon the number of years of marriage and living standards," she said. "But in this economy, the standards in the marriage may not be affordable now and it can be a big shock to a non-working spouse. In California, a non-working spouse or one with lower income will not get support for life, but usually for half the time of the marriage. And if the marriage has been long, and they are nearing retirement, the income will usually stop when the employment stops."
Credit is also a consideration, but if one spouse racked up big bills, unfortunately usually both spouses have to be responsible, said Beck. Credit will have to be reestablished once the divorce is final.
After a divorce, Beck said the assets need to be split and clients need to pay attention and open up the accounts and get the transfers made. Many people think the divorce attorney will do this. "Some do but that needs to be discussed because once the settlement is made, the divorce attorney is usually finished," she said.