Post-Divorce Financial Planning: Organizing Finances During and After Divorce
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Most people don’t begin their marriage expecting it to end in divorce. However, statistics suggest that a significant portion of marriages will ultimately fail, perhaps a third or more. For those who do find themselves ending a marriage, a lot can be on the line financially as marital property, including investments, must be divided. Having a sound financial plan can ease your transition into life as a single person and can help ensure a comfortable financial future after the divorce.
First steps – Dividing up Your Financial Lives
It helps to work with a financial advisor to navigate this process, preferably a Certified Financial Planner™ who will act as a fiduciary and only make decisions in your best interest. Ideally, this advisor will work with you to set goals and objectives for investing and retirement planning as well as managing your immediate financial needs. One option is to work with a Certified Divorce Financial Analyst™ (CDFA™) who specializes in the financial issues surrounding divorce. These advisors can work with a client’s divorce lawyer or as a mediator for both spouses to help reach an equitable settlement.
Finances and Cash Flow – Income that has been supporting one household now needs to support two separate households, so it’s important to take time to list all monthly expenses you’ll have after the divorce to determine whether you will have enough cash flow to cover everything. If you come up short, you’ll need to look for ways to increase your income or decrease spending – not an easy task even under the best of circumstances. One way to ease the financial crunch can be to pay off or restructure debt, if possible. It’s also recommended to avoid large purchases that can cause complications before marital property has been divided.
Close all joint checking and savings accounts and credit cards and open new individual accounts. Once the divorce is finalized, pull your credit report and verify that joint liabilities have been removed.
Assets and Liabilities – Make a list of all your assets, their value, and whether they are owned jointly or separately and prepare a personal balance sheet. Be sure to include safe deposit boxes. Compile bank statements and give copies to your attorney. Determine which assets you would like to keep and those you’d be willing to give your spouse. Don’t transfer or give away any assets that are held jointly without both parties’ consent. Once assets are divided, make sure your home, cars, investment accounts, trusts, and other assets are retitled as needed. Equally important to defining your assets is understanding the liabilities (vehicle loan, mortgage, student loan, etc.) that you will be responsible for. Make sure you know the balances, monthly payments, and interest rates for any debts that you will assume.
For many people, their home will be among their largest assets. You will need to decide whether it will be transferred to one spouse as part of the settlement or sold with the proceeds divided between the two of you. While it might be tempting to negotiate taking ownership of your home instead of retirement or investment assets, this can be a mistake. While you may be sentimental about your home or want to prevent moving your children, homes require an ongoing financial commitment for upkeep and property taxes and are unlikely to appreciate significantly in value.
Caring for Your Children – Although basic child support will be included in a divorce agreement, that’s just the beginning. It’s important to consider how future expenses for your children will be shared between parents. This could include items such as tuition for school and college, music or dance lessons, sports activities, summer camp, travel costs if the parents (or other close relatives such as grandparents) don’t live in the same area, vehicles once the children are old enough to drive, and any other 2
expenses that go beyond the basics. Lastly, make sure both spouses have copies of birth certificates and Social Security cards.
Insurance and Risk Management – Review all of your insurance coverage – life, disability, health care, long-term care, home, and vehicle – to make sure it’s adequate to cover you and your children. You also should determine whether beneficiaries need to be changed on any policies. If you will be receiving alimony, child support, or pension payments from your spouse, it may be very wise to put in place life insurance to cover these items in the event that your spouse passes away. While this may be mandated in your divorce decree, you may want to choose to put in place coverage if it is not. Also take a close look at employer-sponsored insurance benefits to determine coverage post-divorce.
Tax Planning – Consult with your accountant or tax advisor about how the divorce will affect your tax status, including the impact of any spousal or child support. Make sure all taxes have been paid to date. Make sure both spouses have copies of prior-year tax returns (a suggested minimum is two years).
Determine whether you will be in a higher or lower tax bracket than when you were married and how this will affect your overall financial plan. If you anticipate being in a lower bracket in retirement, it may be better to fund pre-tax accounts like traditional IRAs and 401(k)s. If you expect your tax bracket to be higher in retirement, it is likely best to fund after-tax accounts like Roth IRAs or Roth 401(k)s. When you are dividing assets, it is also critical to understand the tax consequences of liquidating any assets you take on. The tax implications of selling a house, selling a stock, distributing an IRA, or withdrawing from a Roth IRA can be very different from a net after-tax perspective.
Estate Planning – Update all of your estate documents, such as wills, powers of attorney, trusts, and health care powers of attorney to make changes to terms, parties involved, and beneficiaries as needed. Also be sure to update beneficiaries on all insurance policies and investment accounts, including employer-sponsored retirement plans so you don’t unintentionally bequeath something to your former spouse after your divorce. This happens more than one would believe due to individuals neglecting to submit beneficiary updates to match a revised post-divorce estate plan.
Preparing For Your Financial Future
After you’ve separated your financial lives, work carefully with your financial advisor to focus on planning your future.
Savings Goals – Determine how your post-divorce financial situation affects your ability to save for goals such as college or retirement and whether you will need to revise your expectations. We recommend creating a plan to maximize your savings.
Investment Strategy – You and your advisor can evaluate your investment allocations to make sure they are appropriate for your risk tolerance and your time horizon. An advisor can help you focus on rebuilding your assets while remaining cognizant of fees.
Retirement Planning – Many receive a Qualified Domestic Relations Order (QDRO) that recognizes a former spouse is entitled to receive a predefined portion of an individual’s retirement plan, usually 50% of the value of the assets gained from the beginning of the marriage to the time of the divorce. If you receive a QDRO, you will need to make sure pre-tax dollars are placed in pre-tax retirement accounts and will need to decide how to manage it. If you do not keep the money in a pre-tax retirement account, you will be responsible for taxes when the money is distributed.
“When you are dividing assets, it is also critical to understand the tax consequences of liquidating anything you take on. ”
Establish an overall plan to determine how much you will need to retire, then stick to it to maximize your nest egg. A mix of both pre-tax and post-tax accounts can provide the needed balance for most investors. One other item to consider is whether the financial impact of your divorce will change your strategy for claiming Social Security and pensions.1
Comprehensive Financial Plan – It is important to understand how each of the areas above work together in your overall plan. Your cash flow determines what you can save for various goals each month, your tax situation determines which kind of retirement savings account is best for you, and your long-term goals impact the type of investment strategy you should use. Consider working with a trusted advisor, who operates in your best interest, to make decisions in these various areas.
As you transition to your life after your divorce, taking steps to strengthen your financial situation can provide a level of comfort that allows you to focus on your emotional health and well-being and that of your children and others close to you.
1 www.socialsecurity.gov – The Social Security web site has a calculator and detailed information on determining when to claim benefit