You can dramatically improve your chances of starting your new life on sound financial footing if you look beyond the divorce settlement and analyze the impact that your decisions will have on your finances in the short and long-term future.
For example, the decision of who will own and occupy the family home certainly has an emotional impact, especially when you have children in school. But what if the spouse who takes possession cannot afford the house, as a home? Beyond the mortgage, there are many expenses including utilities, gardening, repairs, association fees, and general maintenance. Maybe the house could be held jointly for a number of years and sold once the children have moved beyond the divorce process themselves. What is the income tax effect of the eventual sale?
How will the home ownership affect the occupying spouse’s ability to fulfill other family needs such as automobile expenses, food, health care co-pays, school expenses, etc.? There may be other alternatives that could help both spouses financially and at the same time, keep the children “on solid ground.”
The long-term financial results of these transactions also need to be analyzed and compared during the divorce process.
In the situation where one spouse has worked at home while the other started and maintained a career, there are “career assets” that can be the most significant assets of the marriage. In addition to salary, there can be a substantial pension or retirement plan. What about stock options, bonuses, and health, life, and disability insurance? Each of these can have a profound impact on how the marital property should be divided and the amount of support that is needed by the work-at-home spouse.
I have outlined below what factors need to be considered when making decisions about the major financial components of the separation and divorce agreement:
- Inflation affects Alimony, Pensions, IRAs, sale of the family home, and the property division
- Investment Rate of Return affects pensions, all retirement plans, and the property division
- Income Taxes affect all the financial aspects
- Special Legal considerations affect child support, pensions, other retirement plans, and the family home sale
- Cash Flow is affected by pensions, all other retirement plans, and the property division
Inflation – Expenses will not remain the same over the next 5 to 10 year time period. It is important that the income you receive matches at least the rate of inflation.
Investment Rate of Return – Assets will grow at different rates of return and have different financial risk. How much return do you need? How much risk can you take?
Income Taxes – Virtually all the financial choices you will make will be affected by income taxes. Can you withdraw the money from a retirement plan without penalty? If the house is sold, will you have to pay income taxes? Will the monthly income you receive be taxable?
Special Legal – Once the Divorce Agreement is finalized, there is sometimes additional paperwork, e.g. a Qualified Domestic Relations Order (QDRO), which has to be completed before you can take possession of an asset. I always recommend that the preparation of the QDRO begin during the divorce negotiations.
Cash Flow – Employer retirement plans may have restrictions on lump sum distributions. IRAs cannot be withdrawn without penalty (under most conditions) prior to age 59½. This is important to know prior to the final settlement, especially if you need the cash to maintain your standard of living.
In many circumstances, there are crucial steps that must be taken in anticipation of a settlement. An example of this is where your spouse will be responsible for paying child support and alimony. Instead of waiting for the final settlement, you should protect this anticipated stream of income by taking out a life insurance policy on your spouse so that you and your family will be protected. You should be the owner and beneficiary of the policy.
Divorce can be emotionally and financially devastating. You can reduce some of the stress associated with the process by gaining an understanding of the financial issues of your divorce and involving a Certified Divorce Financial Analyst (CDFA) to provide a detailed analysis of financial result of your settlement.