MINIMIZING THE FINANCIAL COSTS OF DIVORCE
By MARY LYNNE DAHL, CFP®
May 21, 2017
The first and most obvious costs are legal costs. If you hire an attorney, this will cost you. Every case is different in some ways, so the costs are quite variable. The longer the divorce takes, the more it usually costs. Other costs associated with divorce are the second household that usually results, meaning that the couple that used to live in one home now live in 2 homes, and this costs money that is a new expense directly resulting from the pending divorce. Combined, these 2 types of expense, new to the couple going through the divorce process, are additional to the usual costs of living. But this is not the end of the costs. The biggest cost is the splitting up of the debts and the assets, called the financial settlement.
First, a little advice about legal costs: You can reduce your legal costs by doing a lot of the preliminary paperwork yourself. This means that you can and should fill out the financial forms required to calculate child support (if applicable) and to reach a financial settlement with your spouse. Most states require this form be completed, and it can be a lot of work, so if you are paying an attorney or his/her staff to do this work, the hours billed can really add up. It is definitely worth your time to answer all the questions and supply all the information asked of you, and your spouse, on these financial data forms that are part of any divorce. You can do the data gathering and let your attorney do the legal work, which will reduce your costs considerably.
The next question is child support: If there are dependents/children of the marriage, state laws govern how much child support those children or dependents are entitled to receive from their parents; the parents cannot determine this on their own. Then, according to a formula required by the state, each parent is allocated a percentage, based on the income of the parent, of whatever the child/dependent will receive. For example, if a child is entitled to support of $1,000 per month and the parents each earn the exact same amount of income, each will be responsible for 50% of that $1,000, or $500 per month per parent. It can be a bit more complicated than this simple example, but you get the point. The bottom line is where children or dependents are concerned; the states have laws that are fairly strict, not very negotiable and not part of the financial settlement that follows the divorce. That financial settlement is the subject of this article, and highlights some really big mistakes to avoid.
The key items in any financial settlement that is part of a divorce are the marital assets and marital debts. Marital assets and marital debts will need to split between the 2 spouses at the time of divorce; this is the essence of the financial settlement that will be negotiated.
Marital assets are those assets acquired during the marriage and as a result of the marriage. An inheritance received during the marriage does not automatically become a marital asset unless it is co-mingled.
For example, if a husband received an inheritance of $100,000 while married and deposits that money into a joint bank account with his wife, he has made it a gift to her by co-mingling the money in their joint account. If he does not co-mingle it, but keeps it separate, it does not become part of the marital assets that are subject to being split at the time of a divorce. Property received as an inheritance can become marital property also, depending on how it is titled. A good attorney is needed to clarify which assets are or are not marital assets, rather than assuming anything on your own. Sometimes it is a gray area and arguable; this is where your attorney can be very valuable. I note that it is wise to hire an attorney for exactly this kind of reason (and other reasons as well), and is short-sighted to try to pinch pennies on issues that could be very costly if handled incorrectly.
Debts are also marital in nature, sometimes even though one spouse may not know about them. I have seen several cases over the years where the paperwork disclosed loans that one spouse was completely unaware of, implicating a whole different life style of the spouse, in some cases going as far as another family in another home in another town. That is rare, but it does happen, so it is important to scrutinize the debts carefully.
A little forensic investigating can uncover all kinds of money issues once the marriage reaches the divorce stage. One of the ways that I have discovered unknown debts and assets is by studying the last few years of income tax returns as well as bank loan applications. It is not always easy to uncover bank loan applications, but a credit check helps in this regard and may be necessary when there is good reason to suspect that one spouse has secreted money away somewhere in an effort to hide it from his/her spouse. It really adds to the stress and pain of a divorce to find out that your spouse has been doing something like this, but it happens and unless it is discovered, it will cost the other spouse a lot of money at the time of the financial settlement to overlook significant assets that may exist.
Generally, the two biggest assets in most marriages will be the family home and the retirement accounts. Splitting these, or other assets, in any percentage, is a big cost to both the husband and the wife. What was once whole is now divided. The family home and the retirement accounts are marital assets if acquired during the marriage. The family home is usually not a source of argument about being marital; that is almost always agreed upon. The question is whether to keep and live in it, sell it or rent it for income. I always point out that if it is kept in order for one of the couple to live in, or if it is rented out for income, the spouse who gets it in the financial settlement needs to understand that there are holding costs associated with real estate ownership. Roofs leak, carpets wear out, landscaping needs maintenance, gutters need cleaning, painting is required every so often, insurance is essential and taxes will need to be paid annually. Whichever spouse wants the family home in a divorce needs to be able to maintain and repair it, which sometimes is not practical. If instead, the couple decides to sell the home, the costs of selling the home can be split, and the gains, if any, can also be split. Making this decision can be emotionally draining, but once made, the actual tasks of selling and splitting are straightforward and easy.
The retirement accounts are also generally marital assets, but in a surprising number of cases, I have heard one spouse, sometimes both spouses, declare assertively that their “retirement accounts are not up for splitting”, even going so far as to declare that “my pension is mine, not his/hers, period”. I beg to differ on this. Retirement accounts are, in fact, up for splitting, because they are marital assets. The easiest way to do this is to determine what percentage of the retirement accounts that are marital, that is, accumulated during the marriage and then divide the value of the accounts by 2 and make up the difference to the spouse with the littlest of 50% (assuming the split will be 50%/50%). With defined contribution retirement accounts, this is easy. These are 401-K accounts, IRAs, SEPs, 403(b) accounts, deferred compensation plan accounts, profit sharing plan accounts and thrift savings accounts, to name a few. However, pensions are not defined contribution plan accounts, so they are not as easy to value; I will explain them later on in this article.
If a divorcing person has a pension that is part of the marital assets, it is a bit more complicated to split it, but it can be done by one of two methods. The more difficult method is a lump sum valuation of the future income from the pension. This requires a lot of expertise to calculate and should not be attempted by the divorcing spouses, the employer providing the pension or the attorney handling the case. It requires financial planning expertise that will estimate the future value of the income and the factors used to discount that back to a lump sum total in the present.
To illustrate this concept, think of a pension providing a pension of $50,000 per year for life to a retiree starting at age 65. The first estimate is how long the retiree will live, so actuarial tables are used. If the tables show life expectancy of 84, the factor will assume that the pension will be paid out for 19 years. The question of how much that is worth is not simply $50,000 X 19 ($950,000). Inflation is part of the calculation of future value and present value, which also requires a projection of the investment rate of return on the unspent principal amount, which will be declining as the years progress. Complicated and probably not the best way to award part of the pension to the other spouse. There is a better way, below.
That better way to split the pension is to use a Qualified Domestic Relations Order (QDRO) document that will do this at the time the spouse entitled to the pension retires. For example, if the spouse who is entitled to a pension of $50,000 per year is about to retire, was employed by the company providing the pension for 35 years and was married for 20 of those 35 years, the marital portion of that pension is 71.43% of $50,000, or $35,715. This amount represents how much of the pension is marital property. A 50% split to the other spouse would entitle that spouse, who will become the “alternate payee” of the pension in question, to $$17,857 per year (assuming there is not a cost-of- living (COLA) increases in the pension of $50,000 per year). The retiree will get the other 50% marital portion of %17,857 plus the non-marital portion of $14,286, or a total of $32,142.
At this point in this article, you are probably getting my point that divorce is expensive in many ways, some of which the divorcing couple is shocked to discover. I can tell you that I have heard the phrase “I had no idea” many times in the last 33 years of providing financial planning to a divorcing individual. It doesn’t end there, however. What I have explained so far is cut and dry, routine and does not include the games and tricks that sometimes are part of a divorce financial settlement. Let me explain further:
I had a case a number of years ago in which I was asked by the attorney for a woman to examine the assets and debts of the case and fashion a fair and equitable financial settlement to present in court to the judge. This couple could not agree, was headed to court and the attorney wisely recommended a certified financial planner expert be brought into the case. So, I examined the documents disclosing the assets and liabilities, but something was wrong. The husband wanted to give the wife the home, valued at $825,000 and paid off entirely (they both said) and keep $600,000 in stocks as part of the settlement.
I found no problem with the rest of the settlement being proposed, but the income tax return, which I requested be disclosed, indicated a large mortgage interest deduction. If the house was paid off, why was the couple claiming the interest deduction from a mortgage? The prior year tax return, which was the only one provided in the paperwork in this case, did not show any mortgage interest deduction. What was going on here? It turned out that the husband had anticipated filing for divorce, completed the paperwork almost a year earlier, attached the prior year tax return as proof of the numbers and immediately following that action, took out an 80% mortgage on the home he was going to offer to his wife in the settlement. In the interim, the next year’s tax return was also filed but not disclosed, so I requested a copy of it. She had no idea of this new mortgage or the more recent income tax return being prepared. Had this not been discovered prior to the case going to court, this man would have exited the marriage with $600,000 in stock plus $660,000 in cash from the refinance of the home, leaving the wife with equity of only $165,000 and mortgage payments that she could not afford. Talk about a costly mistake!
In another case reported to me by a financial planner friend of mine, a couple going through a divorce was not advised that a QDRO was needed to split the pension when the wife retired. She and her husband had agreed that when she retired at age 65, at which time he would be 67, he would get 35% of her pension income, but the attorney did not tell them that a QDRO was required to do this. Instead, it was merely mentioned in the divorce paperwork that he would get 35% of the pension at her retirement. Well, she did retire, but her former employer had no instructions, or legal right, to pay him anything, so they did not. The divorce decree was not sufficient; a QDRO (a court order) was needed, but it did not exist. This couple was left with a serious problem. The ex-wife could write checks to her ex-husband for life, possibly triggering tax consequences, or they could hire another attorney and go back to court to fix this problem. I have not heard how the problem was solved, or even if it was solved.
QDROs are required for pension plans and certain other types of qualified retirement plans, but they are not required for IRAs to be split. Again, a small oversight like this can be costly and divorcing couples who are unaware end up paying the costs unnecessarily.
Most divorce settlements are not so dramatic, and very few end being argued in court. These examples simply illustrate why it is important to pay attention to all of the details of the finances of any couple going through a divorce. Even for middle income families, accurate analysis of the marital assets and debts becomes the core of a fair and equitable settlement. In most cases, when everyone involved is reasonable, this is possible and can be accomplished without too much trauma and expense. Nobody will “win”, and that is not the goal anyway. The goal is a settlement that allows both the husband and the wife to pick up the pieces after the divorce and get on with their financial lives with as little damage as possible.
Divorce is stressful. It is not unlike the death of a spouse; it is the death of a relationship and death brings grief, regret, anger, a sense of painful loss and confusion. Knowing ahead of time that nobody will “win”, that there are costs that can be minimized if disclosed in advance and what to expect can and does lessen the stress. Sometimes a couple, or an individual, will simply not deal with this stuff, sticking his/her head in the sand and living in denial, but this does not work. If you are facing divorce, pick yourself up, dust yourself off, do your grieving in a support group and organize the financial data so that you and your spouse can accomplish the splitting up with a minimum of expense and a fair and equitable settlement for both of you. That should be your goal, and it is achievable.
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©2017 Mary Lynne Dahl, CFP® is a Certified Financial Planner ™ and partner in Otter Creek Partners, a fee-only registered investment advisor firm in Ketchikan, Alaska. These articles are generic in nature, are accepted general guidelines for investment or financial planning and are for educational purposes only.
Mary Lynne Dahl©2017
Mary Lynn Dahl can be reached at firstname.lastname@example.org
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