RECENTLY DIVORCED AND ALONE: A FINANCIAL CASE STUDY
By MARY LYNNE DAHL, CFP®
January 07, 2020
(SitNews) Ketchikan, Alaska - In my prior column, I began with “For married couples, becoming single again, whether from divorce or being widowed, is traumatic and creates many questions about money. This second case study looks at some of the most basic but critically important financial issues resulting from divorce, using real life people, under false names, to illustrate the issues, problems and solutions recommended in a typical case.
Robert and Mary Wilson ended their marriage recently after 25 years. Their 2 children are grown and independent. Robert is 53 and Mary is 51. Both are employed in professions that they enjoy where they intend to remain indefinitely. Both would like to retire at age 65, thereabouts, maybe working part-time after retirement, if they are healthy. Robert has some questions about the impact of the divorce on his financial future and has hired a certified financial planner (CFP®) to help him with the issues that concern him.
Robert and Mary plan to remain friends so they did not get expert financial advice prior to the divorce. It was a do-it-yourself effort with an agreed-upon divorce financial settlement, so he is unsure of some of the effects it will have on him.
Robert consulted with his financial planner advisor, with some very specific questions to start off the meeting. First, however, he outlines the basic financial settlement that he and Mary wrote and agreed to, as follows:
1. Robert has a pension, earned over his 20 years with his employer, a government agency. Prior to that he worked for 6 years with a private company but had no retirement plan or pension with that company.
2. Mary has a 401-K plan that she has been participating in for almost 19 years with her current employer as well. Prior to that she was at home raising their 2 children, going back to work full time after about 6 years.
3. Robert and Mary have agreed that Mary will keep 60% of her 401-K plan and give Robert 40% in a tax-free rollover to an IRA Rollover account that Robert has set up with his certified financial planner. They assume that they can do this themselves after the divorce is final, which is imminent.
4. In turn, Robert will give Mary 25% of his pension benefits, starting at his age 65, when she is 62. Any retirement benefits either of them earn after the divorce will remain theirs alone, not subject to being split between them.
5. They have sold their home, netting $300,000 after expenses. They have agreed to split the money equally.
6. They have about $400,000 in a taxable investment account that they have held jointly since getting married 25 years ago. They have agreed to split that account equally as well.
This leaves Robert with an unknown future amount in an IRA Rollover from the distribution of 40% of Mary’s 401-K account, plus $350,000 in cash from the sale of the home and the split of the taxable investment account. It also leaves him with 75% of his pension benefit at age 65, rather than the full benefit he would have gotten had he stayed married to Mary.
Robert wants to know if he should use all $350,000 or just $150,000 of the cash to buy another home, and is concerned about retirement, wondering how much actual income he should expect to have. The answer will have a major impact on how much home he will buy, if any, and what lifestyle he will be able to afford, as well as whether or not to plan on working part-time after age 65.
After several meetings and some data gathering by his financial planner, she gives him the following plan, which will address his issues, provide answers and allow Robert to move on with his life confidently. Here is what she recommended to Robert:
1. Have his financial planner do a realistic and reasonable projection of his future pension benefits, Social Security retirement benefits, and income that can be generated from growth of the IRA Rollover money that Mary has promised to him. This projection will be to his age 65, using moderate rates of growth on investments and the actual pension benefit formula used by Robert’s employer sponsored pension plan.
2. In addition, during the data gathering part of their meetings, his CFP discovered that Robert and Mary did not have Qualified Domestic Relations (QDROs) drawn up as part of their settlement agreement, and should do so immediately, with court approval on each QDRO. This is very important when a couple intends to split a pension or 401-K plan with their divorcing spouse. It is not required with IRAs that are being split, but without the QDRO in place on the pension, Mary would not receive her 25% and without a QDRO on the 401-K plan distribution, the amount distributed will not transferred to Robert, plus if distributed to Mary instead, it will be taxable in most cases. Robert was not aware of these issues and agreed to explain them to Mary immediately so that they could hire an attorney to obtain QDRO forms, fill them out correctly and submit them to the court for the record.
3. The future value of all of these sources of retirement income will provide Robert with a close approximation of his retirement income starting at age 65 or 66. The plan should be reviewed at least every couple of years to make sure nothing has changed and that Robert is on track.
4. After the projection of all future income is calculated and discussed, Robert can decide whether or not to buy another home/condo and if so, how much of his cash to spend on getting into it. If it turns out that the future value and income projection of his retirement income will not provide Robert with the income he wants or will need to live the lifestyle he sees for himself in retirement, Robert has the choice of either adjusting his current budget downward in order to save and invest more of his current income, or invest all of the cash for retirement rather than buying a home/condo, or working part-time after age 65 or some combination of these choices.
The place to start when you face important financial decisions like these, or others, is to sit down, taker stock of the situation, gather the data you will need to make a good decision, and then develop a plan. A good plan is a step-by-step process, not a do and forget about it thing. It often works better with expert financial help, particularly in a divorce. Everyone who goes through divorce experiences a form of grief, a type of trauma, and everyone struggles to some degree with the hard choices that generally result from divorce. A good plan to recover not only provides a roadmap to good decisions, it also buys peace of mind. Becoming single again, especially after years of marriage, is pretty devastating to a lot of people, but a good financial settlement plan will help heal the wounds and put the newly single person back on the road to a healthy financial and emotional status.
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