Divorce is an emotional crisis, but it doesn't need to be a financial disaster. Financial mistakes in the negotiations of a divorce settlement are sure to be costly to one party or the other.
The key is to understand what is best for you in the long run and not do what seems easiest in the short term. You are about to make financial decisions that will impact the rest of your life. Remember, your divorce attorney is not a financial expert. Further, unforeseen consequences of a financial mistake can take several years to become evident. But when they do, it is real.
I believe that no divorce should happen without the input of a divorce financial professional. To do so is like saying you will have surgery on your finances, but not invite the surgeon. (For more, see: Get Through Divorce With Your Finances Intact.)
Here are three financial mistakes to avoid when going through a divorce:
1. Keeping the House
The most common, and potentially most damaging, mistake in a divorce settlement is for one of the parties to keep the house. Too often, this is an emotional decision, rather than a financially sound decision. There are many emotional reasons to want to remain in a house: the memories, familiar neighborhood, or schools.
However, none of these may make good financial sense and can make you "house poor" - having a lot of house and little else to take to the grocery store. Remember, you have a house that was selected for two adults, and now there will be one. The house may have required two incomes to support it, and now there will be one. Something smaller may be the better financial decision.
Do a thorough analysis of what the house costs including maintenance, taxes, utilities and other items you may not think about on a daily basis.
In addition, you will need to "buy out" your spouse’s share of the equity by either giving up other valuable assets or pulling more value out of the house in a refinance. If you currently have a joint mortgage, or if it is in your spouse’s name, you will need to refinance anyway, but with a buy out, the mortgage will be higher. If you are not able to buy out your spouse's share of the equity, you will have a more complex form of joint ownership going forward.
2. Not Accurately Calculating Future Expenses
Far too often, estimates of future living expenses are just not accurate. It may have been a long time since you had to think about what it will cost one person to live. Two can live almost as cheaply as one. Therefore, two living separately becomes much more expensive all at once.
Between the two of you, combined future expenses may go up 20%-40%. However, there will be no additional money to cover these expenses, no matter how it is divided. Unless you are currently living below your means, you should each expect your standard of living to decline somewhat. (For more, see: Divorce Planning Checklist: What You Need to Know.)
Accurate expenses are critical if you will be negotiating spousal support, also known as alimony, no matter which side of those negotiations you will be on. If you anticipate receiving alimony, you will need to know how much you need, otherwise you will not be able to ask for it. If you anticipate paying alimony, you need to know how much you need for yourself, so you don’t lose it.
If you have children, child support only goes so far. It is important to consider that where the kids live, their friends will gather as well. A few extra teenagers can consume your entire week's groceries in a couple hours. Since child support is awarded according to state guidelines, this is usually not an area open to negotiations. However, you still need to know what it will really cost to live going forward.
3. Not Being Aware of the Impact on Taxes
Tax issues surrounding the financial aspects of divorce are often misunderstood or overlooked. The areas most likely to be of concern are income taxes, capital gains taxes, and child-related deductions and tax credits.
Income tax obligations as single individuals (or head of household) will differ. You and your former spouse are likely to be in different tax brackets. Therefore, the terms of nearly every other financial issue may have different values to each of you. Knowing what something is really worth to you, or your spouse, will enable you and your attorney to negotiate better for what you want.
Capital gains taxes may influence the disposition of the house, which is subject to a capital gains exemption under proper circumstances. Lack of good planning regarding exactly how and when it is sold could result in a costly mistake. If capital gains had been rolled into the marital home from other houses owned before 1997, old tax rules will apply to determine the cost basis of the current house.
Potential tax obligations due on investments, upon future sale, will impact their current value to each of you. For instance, two brokerage accounts having the same monetary balance of $300,000 may not have the same real value if one of them has potential capital gains taxes, which will reduce its net assessment, and the other does not.
Retirement accounts present complex tax considerations with some special exceptions for circumstances of divorce. Funds which are generally not available without penalty may be accessible within certain limits and procedures.
We are undergoing the implementation of significant tax reform passed in the Tax Cut and Jobs Act (TCJA) of December 2017. Most changes were effective as of January 2018, but we have yet to actually file taxes accordingly and much confusion and misunderstanding persists.
The effective date of the most significant change in alimony taxation in over 75 years was delayed until January 2019. Major changes in rules for tax deductions, as well as tax credits, which may or may not be available to one parent or another, makes a parenting plan negotiation equal parts financial as it is parenting.
Additionally, there are provisions that most of these tax reforms are due to sunset after 2025. That means they will end, unless extended at that time, and we will revert to the previous rules at just about the time they become forgotten.
Choose the Right Divorce Financial Consultant
Going through a divorce will force you to make the biggest financial decisions of your entire life at a time when you may feel the least capable of doing so. Get the help you need. Your divorce financial consultant should have two key qualifications:
- First, they should be a licensed financial advisor, qualified and experienced in providing financial advice.
- Second, they should have additional credentials as a divorce specialist, having studied, tested and successfully applied, in practice, the legal and financial particularities of divorce.
Further, buyer beware. You do not want someone whose greatest qualification is that they themselves are divorced and like to do math. They are not a financial professional.
You do not want a financial advisor who lacks divorce financial credentialing. They are a generalist. Use them for other needs.
You also do not want someone who will not charge you a fair market price for services in anticipation of managing your assets post divorce. They cannot afford to give you all that you really need. This is just a long sales process for them.
The right divorce financial consultant will help you get through your divorce in the most financially beneficial way and avoid costly mistakes during the difficult and financially confusing process. The financial decisions you make during this time can impact you for the rest of your life, so it is important to make these decisions carefully. (For more, see: Getting a Divorce? Understand the Rules of Dividing Plan Assets.)
Disclaimer: Rosemary Frank Financial, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance. Rosemary Frank is not an attorney and does not provide legal advice.