Divorce Financial Planning: What It Is and Why You Need It
David K. Little, CFP®, CFA
While no one goes to the altar to get married with the expectation that they’ll end up divorcing their new spouse, the unfortunate fact is that in Orange County alone, more than 50% of marriages end in divorce.
As Fullerton financial advisors, we’ve dealt with the financial consequences of divorce here in Orange County and elsewhere and believe there are some financial issues that divorcing spouses need to consider as they go through the divorce process.
The divorce settlement is the first matter to make sure you get good financial advice on. Divorce is final, and you don’t want bad financial decisions made during the process to affect you for the rest of your life.
Probably the most critical point to consider in the settlement document is tax consequences of the divorce. I like to say that an asset is almost never just an asset, unless it’s cash. Most other assets come with tax liabilities, which make them worth far less than an equivalent amount of cash. Consider the following example, which is actually a true story and was incorporated into a client’s settlement document.
The petitioner (the wife in this case) was to be awarded $200,000 in cash. The respondent (the husband) was to receive the remaining $200,000 of his retirement account, which was virtually the only asset he owned. The attorney in this case had written up the document thinking that this would be an equal split and would leave each divorced spouse on a similar footing.
As we reviewed and analyzed the document, we immediately told the husband that because of the way the document was written, he’d need to cash in his retirement account to get his soon-to-be ex-wife the $200,000 specified in the document.
That would mean liquidating about $300,000 of the retirement account, paying $100,000 in taxes, and writing her a check for $200,000. At the end of the process, she’d have $200,000 in the bank and he’d have only $100,000 left in his retirement account. And to make matters worse, he’d have to pay taxes on that $100,000 to withdraw and spend it, which made it equivalent to about $70,000 in cash.
In this case, we stepped in and called this to the attorney’s attention and our client’s attention. And because we did so before the divorce was finalized, the document was redrafted to make the settlement more equitable for our client.
The moral of this story is to ask questions of your divorce lawyer to make sure that they are taking all consequences into account as they draw up your agreement. Having your tax accountant review the document would also be a good idea.
In addition, if the situation is complicated enough, there are Certified Divorce Financial Analyst® (CDFA®) professionals available to work with you. Paying a little more money up front to have this expertise will probably save you significant expenses or disadvantages in the long run.
Numerous other issues need to be considered if you’re going through a divorce. Here are just a few:
Recognize that two people can’t live as inexpensively on their own as they did together. This fallacy is perpetuated by people’s beliefs that they’re entitled to the same lifestyle they had when they were married. Some decrees even reference this belief by stating that one spouse should be able to keep the lifestyle to which he/she are accustomed. Unfortunately, as we’ve run numbers for clients, it always works out that both spouses will need to reduce their lifestyles to some extent. Maintaining two houses, even if they’re smaller than the marital house, is almost always more expensive than maintaining just one household.
Make sure to change beneficiaries and update your estate plan. Dealing with estate planning issues while going through the emotionally difficult process of divorce is not easy, but it needs to be done. We’ve seen numerous examples of beneficiary designations naming a client’s ex-spouse years after a divorce has been finalized.
Make sure you’re on track for retirement. While retirement probably won’t be the same as you anticipated before the divorce, knowing what it should be like is important. Figuring this out as soon as possible will allow you to adjust your expectations (and maybe your saving rate) and give you time to make any necessary changes.
Schedule a 15-minute discovery call with a fee-only financial advisor to discuss your personal situation.