Eight Financial Considerations of a Divorce

By Diane Gardner, CFP®, CDFA®
LPL Financial Advisor

An Overview of Marital Transitions - In the process of a divorce, there are three major aspects to consider – financial, legal and emotional. At some point in time you will need a plan for all three. While all three likely will not occur at the same time, each will be essential for helping you through the process. Remember that the decisions you make now will affect you in the future. As settlement options are presented to you and your attorney, the advice of a Certified Divorce Financial Analyst ™ may be beneficial. Making sure you understand the tax implications of decisions along with understanding how the investments and assets work is crucial to your decision making.

Financial Aspects of Divorce - The financial aspects of divorce can seem overwhelming. It is difficult to make financial decisions when one’s emotions are on a roller coaster. It is important for women going through the entire divorce process to evaluate their situations and come up with their new plan after the divorce is final. These five areas are critical – knowledge, documents, retirement and Social Security, budgeting and the financial future.

Knowledge is Key in a Divorce - Gain as much knowledge as possible no matter where you are in the divorce process. Having knowledge eases anxiety and allows one to make more informed decisions. Know that the decisions you’re making now will impact your future. Often one spouse runs the finances. If that spouse wasn’t you, you may feel in the dark and not knowing what has gone on with your household finances. You may not know where accounts are housed or how much money was in each account. If you find yourself in that situation, it’s OK. What’s important now is to start learning and to be in control of your cash accounts such as checking and savings. Keeping an eye on those accounts may help your transition if needed in the future.

Documents: Vital in a Divorce - Having your financial documents at hand is vital in the divorce process. These can range from tax returns, bank statements, investment statements and retirement statements such as 401 (k), 403 (b). All of these are very important documents, and you will need to have copies of each. They will provide you with where each account is housed and how much money you have/had in each one. They also present a roadmap if needed to show where funds have been moved. Be sure to obtain copies of credit card statements, loan papers and any other debts you may owe. Develop a balance sheet of all your assets and liabilities as an inventory that your attorney and financial advisor can use to see your entire financial picture. Don’t forget inherited property. If kept separate from your spouse, you need to be able to trace it back in time to show that the original amount was truly inherited.

Retirement and Social Security in a Divorce - When reviewing retirement assets, just because your spouse’s name is the only one listed on the account does not mean you don’t have a marital claim. It is still considered a marital asset and subject to division. If it’s determined through the divorce process that you are entitled to some of the retirement assets, they will be moved using a “QUADRO” (qualified domestic relations order).

You have several options to consider on how you want the assets. The QUADRO will permit them to either remain at the sponsor firm titled in just your name, allow you to transfer the assets to your own individual retirement account at another firm or cash them out altogether. If you choose the rollover option, you can take out one distribution prior to the rollover and avoid the 10 percent penalty if you are younger than 59½. You would pay tax on the distribution amount. The amount placed in your IRA would not have to be reported on your tax return.

If you choose to cash out the portion of the retirement account, the 20 percent withholding usually applies in addition to current income tax. If making new contributions to a traditional IRA, contributions may be tax deductible in the contribution year, with current income tax due at withdrawal. Plus, you would want to consult your tax advisor on the impact a withdrawal would have on your taxes, knowing that it would mean less money for you. Pension plans are also subject to division. In a pension scenario, you would be known as the alternative payee and at retirement age you would begin to receive those payments.

Social Security Aspects of a Divorce - If you have been married for longer than 10 years, you are entitled to half of your spouse’s Social Security or your Social Security, whichever amount is higher. The amount is determined from the marriage start date to end date, but not at the date of separation typically used by courts of law. If your spouse’s amount would be greater than yours, the amount you receive does not affect his benefit. For example, if your ex would receive a monthly $3,000 Social Security payment and you only $1,200, you could file under your ex to receive $1,500 per month. By taking the $1,500, you would not affect his amount, and he still would receive $3,000 per month. If you remarry, you would forfeit your ex’s amount. You would be considered at your current husband’s amount. If you divorce again after 10 years, the same rule would apply. If after the divorce your ex-husband dies, you may also be entitled to a widow’s benefit at 100 percent even if he has remarried. Check with your local Social Security office for help in reviewing those numbers.

Budgeting - Budgeting is an important part of the divorce process. Initially if you are considering filing for alimony or child support, you need to know precisely what your expenses are. Creating a budget with back up such as voided checks or invoices will provide factual information to your attorney. Alimony is taxable, so keep in mind the amount you receive will be reduced by taxes. Child support is not taxable. Be sure to include items in your budget such as after-school programs for your children as well as summer camps or sports activities. Often, people don’t realize how much their kids actually cost in dollars and cents. The budget will also help you determine what assets you can afford to keep after the divorce such as the family home. While both spouses always want to keep the house, the question is whether it can be afforded. Budgeting the taxes, insurance and upkeep may show that you need to downsize to have enough money for living expenses. Consider having a home inspection to see if any repairs need to be done and what the cost would be.

The Tax Aspects of a Divorce - There are a few tax traps to avoid in a pending divorce. Individual retirement accounts are taxable accounts and you can also incur a 10 percent penalty on withdrawals if you are younger than 59½. Keep in mind that because of taxes you will pay, $100,000 in an IRA does not equal $100,000 in a savings account. For a family home, single individuals receive a $250,000 exemption on the gain from the sale while married couples receive $500,000. Whether it is more tax efficient to sell the house while still married and divide the proceeds all depends on the taxable gain from the sale.

Cottrill Arbutina Wealth Management Group and LPL Financial do not provide legal or tax advice. Please consult your legal or tax advisor regarding your specific situation.

This is a hypothetical example and is not of any specific investment. Your results may vary.