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Special Circumstances - Divorce


Divorce planning
A sound financial foundation built over the course of years can be ruined in short order upon the breakup of a marriage. When divorce is inevitable, it is in the interests of both spouses to engage in some financial planning.

Financial issues relating to divorce:

  1. Property settlements - Marriage creates certain rights in the property of each spouse. Upon divorce, marital property is divided according to equitable distribution statutes adopted by many states. What happens with the marital home usually is one of the biggest issues in a divorce. A prenuptial or postnuptial agreement may supersede equitable distribution statutes.
    • Section 1041 - The federal tax code stipulates any gain from the sale or transfer of property to a former spouse as a result of a divorce is tax free. No gain or loss is recognized.
    • The family home - Careful consideration should be given as to whether a divorcing spouse can afford to maintain the family home. If neither spouse can afford to maintain the home, it may need to be sold and the proceeds divided. Joint ownership for a period of time (such as until a child attends college) is a common option, with expenses shared and proceeds split when it is eventually sold.
  2. Alimony and child support - Regular payments from one former spouse to the other frequently are elements of a divorce settlement. How the payments are structured determine whether they qualify as alimony or child support.
    • Alimony - is deductible by the payer for income tax purposes. For the recipient, alimony is taxable income. There are strict requirements for payments to qualify as alimony, as opposed to child support:
      • Payments must be made in cash.
      • Payments must be received under a divorce or separation agreement and not paid on a voluntary basis.
      • The payer and recipient must be living separately at the time of the payments.
      • There must be no agreement to identify the payments as other than alimony for tax purposes.
      • There must no agreement to continue payments after the recipient's death.
      • The payments must not be treated as child support. Any payments that would be reduced or eliminated under conditions related to a child (such as death or reaching a specified age) would be treated as child support.
    • Child support - Payments made to provide support to a child are neither tax deductible to the payer nor taxable income to the recipient. Payments reduced or ended upon an event happening to a child will be considered child support and not qualify for treatment as alimony.
  3. Retirement assets - After the home, retirement plan assets and rights frequently are the marital property with the greatest value. Federal law allows ex-spouses to receive a share of retirement benefits earned during the marriage.
    • Qualified Domestic Relations Order - Court-ordered document that tells retirement plan administrator how to divide benefits between divorcing spouses.
  4. Social Security - A divorced person may qualify for higher Social Security benefits under their ex-spouse's earnings history if the marriage lasted at least 10 years and he or she has not remarried.
    If these conditions are met, the divorced person is entitled to the higher of the benefit based on his or her own earnings record or an amount equal up to 50% of the former spouse's Social Security benefit. This does not affect the benefit collected by the other former spouse.
    If a marriage is close to the 10-year mark, it may be worthwhile to delay the divorce until the 10-year requirement is met. This is particularly true if one spouse earns significantly less than the other.
  5. Health insurance - Ensuring health insurance coverage is an important consideration for a divorcing spouse.
    • COBRA rights - Under the federal COBRA law, a covered worker's former spouse and children are eligible to continue group health insurance at their own expense for up to 36 months in companies with 20 or more workers.
    • Life and disability insurance - These types of coverage also should be reviewed upon divorce to ensure adequate protection. Life and disability insurance may be required to ensure alimony or child support payments continue upon the death, illness or injury of the payer.
      Life insurance with cash value becomes part of the property settlement process. Owner of life insurance policy may decide to change beneficiaries if settlement does not require continued protection of a former spouse or children.
  6. Budgeting -Upon separation or divorce, both spouses are likely to face significant reductions in income and/or increased expenses for items like separate housing and childcare. These financial consequences will require the divorcing spouses to review expenses and income and consider downgrading the lifestyles to which they had been accustomed.
    Prepare a realistic post-divorce spending plan or budget based on individual sources of income, including alimony and child support.
    Consider ways to increase income, such a second job or a side business.

Other steps to take
Certain steps should be taken immediately, ideally in consultation with an attorney, once divorce becomes inevitable.
  • Section 1041 - The federal tax code stipulates any gain from the sale or transfer of property to a former spouse as a result of a divorce is tax free. No gain or loss is recognized.
  • The family home - Careful consideration should be given as to whether a divorcing spouse can afford to maintain the family home. If neither spouse can afford to maintain the home, it may need to be sold and the proceeds divided. Joint ownership for a period of time (such as until a child attends college) is a common option, with expenses shared and proceeds split when it is eventually sold.
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