Divorce can be an emotionally and financially draining experience. If you have exhausted all alternatives for resolving your differences and divorce is your only option, it is best to go into the process with your eyes wide open to some of the potential financial pitfalls.
Many divorce attorneys are knowledgeable about the financial issues of divorce, but some are not. Many decisions are made based on emotion rather than practical financial sense. One of the biggest things I have come across is where a non-working spouse (who is usually the spouse responsible for the couple’s children) wants to keep the marital home. This is pitfall one.
A dependent spouse can often be left cash poor if that person receives the marital home as part of the divorce settlement. Maintaining the marital home often seems like the right thing to do for the children to provide them with consistency, etc., but not if the newly divorced parent cannot afford to do it. Even with alimony and child support, it may be difficult to pay the mortgage, utilities, insurance, car payment, tuition and all the other expenses that go into maintaining a home.
A second pitfall is the assumption that all assets have the same value. For example, let’s assume that the marital assets consist of $150,000 in IRAs and a $150,000 home. Some would assume that if one spouse got the home and the other the IRAs that all things are equal. This would be a wrong assumption. If the spouse with the home sold it at some point in the future for the same $150,000, they would not have to pay any federal income tax under today’s tax code. If the other spouse were to cash in some of the IRAs he/she would have to pay federal income taxes that could range from 15 percent to 33 percent under today’s tax rates (as well as a 10 percent penalty if they were under 59 ½). Assuming the 15 percent federal tax rate, that person would pay $22,500 in federal taxes. In reality, the $150,000 IRA would be worth $127,500 and possibly less.
Another major area of contention is the split of a pension. The spouse with the pension often prefers to give up other assets to preserve his/her pension. Pensions can often be the most valuable of all marital assets. The valuation of pensions is complex and really needs to be done by the pension plan’s actuary or another qualified consultant. If you are the spouse without the pension, do not take this for granted.
A fourth area of consideration has to do with property settlement notes. These are agreements that are used to equalize divorce settlements when assets are not easily split. In this type of situation, one spouse may receive an unequal share of the marital assets in return for a commitment to make a certain number of payments to the other spouse. There are potential tax considerations with this type of arrangement, which should be reviewed with an accountant.
Finally, not enough attention is given to women over the age of 50 who get divorced. If these women have been dependent spouses for most of their married lives, they generally have a much harder time creating an income source for themselves than younger divorcees. Budgeting and cash flow management are critical for women in these situations. It would certainly make sense for women in this situation to seek help from a qualified financial professional.
Jim Heisler is a Certified Financial Planner with Family Wealth Services in Holmesburg. You can read all his Financial Perspective columns here.
Registered Representative, Securities offered through Cambridge Investment Research, Inc., A Broker/Dealer, Member FINRA/SIPC and Investment Advisor Representative, Cambridge Investment Research Advisors, Inc. a Registered Investment Advisor. Family Wealth Services, LLC and Cambridge are not affiliated. Jim Heisler, CFP®, CDFA™, CASL™ Family Wealth Services, LLC 8725 Frankford Avenue Philadelphia, PA 19136 email@example.com 215-332-4968