Divorce is ugly, but armed with the right information you can alleviate anxiety, expedite the process and achieve your desired financial outcome during divorce proceedings.
Talk to a Professional
I recommend seeking the advice of a Certified Divorce Financial Analyst (CDFA) in addition to a lawyer. The reason is twofold. Attorneys are experts in law, but not in finance. They may not understand the complexity of different retirement plans or deal with the calculations of asset division, taxation and penalties, etc. A CDFA can help you tally up your assets and draft your budget, so you are more likely to be calm and reasonable in negotiating what you want and how far you can push. Sometimes people get caught up in a moment of irrationality and argue about things like heirloom silverware, without understanding that the time and money spent on the attorney’s fees could have purchased those items many times over. (For more, see: Marriage, Divorce And The Dotted Line.)
Secondly, even though some attorneys are knowledgeable about finance, they can’t be their own expert witness in court. I recommend seeking a CDFA’s help first, because you can save money, time and headaches down the road.
Read and Understand Documents Before Signing
Don’t be persuaded or forced into signing any documents you haven’t read or understood as the consequence could be irrevocable. Over the years, I have seen people come to me for advice after they already signed the divorce decree. At that point, no amount of good advice can save you. Even if you are lucky enough to get the court’s attention, the first question from a judge may be, “Do you know how to read? If you disagree, why did you sign the document in the first place?"
Besides these tips, here are some common mistakes.
1. If It’s Not in Writing It Doesn’t Count
This is kind of “speak now, or forever hold your peace.” Many couples may have worked out some sort of informal agreement in hope of bypassing an attorney and/or saving the fees. However, the chances are those wishes or agreements may not be carried out or enforced by law later without being incorporated into the formal decree.
2. Minimizing Risks
On several occasions I have seen that using life insurance to guarantee the spouse’s alimony is not automatically carried out on the final divorce decree. Unless you know about it, that omission can be a costly mistake. This also extends to disability insurance. Say the person you are divorcing is a surgeon, without disability insurance, he/she can’t pay your alimony if there is an injury that stops the earning. A CDFA has the knowledge to be aware of all those risks that are usually mentioned, discussed and noted in the final decree.
3. The House
This is probability the number one argument among couples. Often it’s the wife who wants to keep the house for sentimental reasons: kids were born there, it’s zoned for a good school or it’s already paid for. But here’s the ugly truth - unless both spouses earn an equal amount of income, one will be always at the mercy of the other’s financial support. If one spouse merely skips a couple of payments, that’s going to cause an avalanche of problems such as missing mortgage payments, being downgraded by the credit agencies, not to mention the constant anxiety. (For more, see: Getting a Divorce? Understand the Rules of Dividing Plan Assets.)
If you want to keep the house, make sure you do the homework or budget in advance so that you can have the positive cash flow to keep up with the mortgage payment, taxes and regular house maintenance costs. Even if you own your home free and clear, it may still cost you for periodical handyman services for house maintenance.
4. Beware of Retirement Account Transfer Penalties
Whenever there is a retirement plan (401(k) or IRA) involved, you should separate the money that you need for immediate needs prior to a transfer to avoid the 10% early distribution penalty. This is the so called 72(t)(2)(c) exception rule. Once the money is rolled over and then taken out to pay bills, you are required to pay that 10% penalty tax if you’re younger than 59½ and not qualified for any IRS prescribed exemptions.
For example, pursuant to the divorce the wife is entitled to $100,000 in an IRA and she’s under 59½. She has the ex-husband's 401(k) plan administrator transfer $80,000 to her IRA and distribute the remaining $20,000 directly to her to pay for bills. She will certainly pay income tax on that $20,000, but not the 10% tax penalty. Had she transferred the entire $100,000 to her IRA first and then taken $20,000 out for expenses, she would have paid the 10% penalty on top of the regular income tax.
5. College Expenses
With the ever rising cost of education, it is no wonder this is another sore subject for couples. Furthermore, the courts treat children older than 18 as young adults. In their opinion, paying for college does not have the same priority as paying for the minor’s support. A good suggestion is to iron out who pays what and at what frequency and incorporate those agreements into the final decree.
6. Tax Exemptions
Just because a child stays with one custodian parent most of the time throughout the year, it does not mean the other parent permanently loses tax benefits (a personal exemption, child tax credit, earned income tax credit, college tuition deduction or credits, etc.). By signing an IRS form 8332 (Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent), the custodian parent can alternate those benefits with the other non-custodian parent. Knowing that, you can use it as a valuable negotiation tool to bargain.
Case in point: One of my clients who adopted this suggestion negotiated $40,000 more for the house buy out. After reviewing his previous years of tax returns and knowing his earning ability, having the tax exemption is worth more to his wife than to him. So in exchange for giving up the exemption, my client got the final $90,000 payout, from an initial low-ball offer of $50,000. Needless to say, my client was very happy with the extra cash.
In conclusion, divorce is stressful but mastering some financial knowledge can greatly enhance the outcome while minimizing the risks. (For more, see: Get Through Divorce With Your Finances Intact.)
Disclaimer: divorce laws vary from state to state, thus it’s important to consult your local attorney for any legal recommendations.