Divorce can be emotionally and financially unsettling. During this nerve-racking process, financial decisions are made with far-reaching repercussions. Your financial security depends on being well-informed both while negotiating a settlement, and afterward when adjusting to a new financial reality.
During settlement negotiations, the most important financial consideration is that not all assets with equal nominal value have equal value to you. What do I mean?
Consider these different assets that you may be dividing with your soon-to-be ex-spouse:
1. Traditional 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 liabilities.
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 a broker commission and other selling expenses, and may also incur capital gains tax. Even though you need somewhere to live, the value of this asset should be adjusted downward to account for these expenses.
3. Ownership claims in privately-held businesses. 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.
- There may be a complex web of future tax liabilities.
You may want to get professional guidance to help sort out what is fair in these situations.
4. Taxable savings and investments may have unrealized capital gains if their value has appreciated over time. You should adjust the value of this asset downward to reflect this future tax liability. However, depending on the tax basis, this is likely to be a more valuable asset in a settlement than the prior three.
5. Roth retirement accounts are the most valuable assets to receive in a divorce settlement. Typically, they have no future tax liability and better than taxable savings, the future investment income is sheltered from taxes.
Once the divorce has been finalized, you will adjust to a new financial reality, including financial decisions and responsibilities for which you may have previously relied on your ex-spouse. This may include:
- Budgeting — adjusting to a lower household income but with expenses that have not reduced proportionally
- Retirement saving — understanding how much to save and making choices about how to invest 401Ks and/or IRAs
- Insurance — purchasing the appropriate amount of coverage, possibly including life insurance for your ex-spouse
These decisions are challenging in the best of times but the stress of a divorce can exacerbate them. For help with the financial aspects of the divorce process, get in touch.
PS: For those of you in the Boston area, I’m presenting a workshop on Developing Financial Literacy During and After Divorce in October. You can sign up here or contact me for more information.