Divorce and Your Finances

Divorce is emotionally and financially unsettling. During this nerve-racking process, financial decisions are made with lifelong repercussions. Your future financial security depends on being well-informed both while negotiating a settlement, and afterward when adjusting to your new financial reality.

Negotiating A Divorce Settlement

During settlement negotiations, an important financial consideration is that not all assets with equal nominal value have equal value to you.

Consider these different assets that you may be dividing with your soon-to-be ex-spouse:

1. Pre-tax retirement accounts (i.e., IRAs and 401Ks) are encumbered with a future tax liability when you take distributions. If you need to access them before retirement age, you may also pay a penalty. Thus, the value of traditional retirement accounts should be adjusted downward to reflect these future taxes that will be paid. Also, the ex-spouses may be in different tax brackets at the time of distributions in the future and this, too, affects the net value of this asset.

2. Residential real estate is encumbered with many expenses — e.g., ongoing maintenance, repairs, insurance, and property tax. When you sell it, you will incur significant selling expenses, and may also incur capital gains tax. Even though you need somewhere to live, the value of this asset should be adjusted to account for these expenses.

3. Taxable savings and investments may have unrealized capital gains. You should adjust the value of this asset to reflect any future tax liability. However, depending on the tax basis, this is likely to be a more valuable asset in a settlement than the prior two.

4. Roth retirement accounts should have no future tax liability. They are the most valuable assets to receive in a divorce settlement and are better than taxable savings as the investment income is sheltered from future taxes.

5. Employment-based stock and options in publicly-held companies are tricky to value for settlement purposes especially if these benefits are not yet vested. They have no certain value until they are vested at a future date and probably depend on the person’s continued employment. Even if the equity is vested, it may not be sellable at the present time for various reasons.

6. Ownership claims in privately-held businesses are even murkier to sort through. These include partnership interests in professional service firms, small businesses, commercial real estate, and private company stock or options. These assets are difficult to divide equitably for several reasons:

• They cannot be precisely valued.
• The spouse who controls these assets will have more information about their true value.
• The asset’s value may be tied to the spouse’s employment or expertise.
• There may be a complex web of future tax liabilities.
• They cannot be easily sold.

If the marital assets are substantial and complex, consider getting input from a tax or financial advisor.

Spousal support is also difficult to precisely value. Circumstances change over time for both the payor and recipient of support payments so there is no certainty of these payments continuing at the same level. Thus, it’s critical to understand how the “present value” of this support relates to the division of assets during settlement negotiations. For example, it may make sense for both parties to trade off some or all spousal support in exchange for a different split of marital assets.

Adjusting to a New Financial Reality

It’s simple math that both parties are worse off financially after a divorce. You’ve each incurred legal expenses to resolve the split and more importantly, the remaining net worth and incomes are now divided across two households. This is an adjustment for everyone and if there are children involved, it becomes even more challenging. Child and/or spousal support payments create more tension and uncertainty. It’s a trying time for all.

You’ll want to re-set your financial expectations and spending level to your new financial realities as soon as you are emotionally ready to face this.

Post-Divorce Financial Management

You may face new financial decisions and responsibilities for which you previously relied on your ex-spouse. This could include:

• Budgeting — adjusting to a lower household income but with expenses that have not reduced proportionally
• Retirement savings — understanding how much to save and how to invest those funds
• Emergency savings — the amount you need is situation-specific but could easily be 3 to 6 months of living expenses
• Insurance — purchasing the appropriate amount of coverage, possibly including life insurance for you or your ex-spouse

These decisions are challenging in the best of times but the stress of a divorce can exacerbate them. When you get a handle on these issues, you’ll begin to normalize your new financial situation and move on with your life. A financial planner can help with both the pre- and post-divorce process.