Divorce can be draining both emotionally and financially for all parties involved. While no one should stay in a relationship simply because of financial matters, there are many misconceptions and misinformation regarding the financial impacts of divorce. With recent statistics from the CDC suggesting that between 35 and 50 percent of first marriages in the United States end in divorce, it is important to be aware of some of the costly financial mistakes couples often make when choosing to go their separate ways. Avoiding the financial mistakes below may help make the challenging process of divorce a little easier.
Not considering collaborative divorce or mediation
From child support and custody to alimony and dividing assets, the process of untangling years of marriage is complex. Too often couples engage in a hostile divorce process, trying to outwit the other and their attorney which ultimately ends in astronomically high attorney fees and further emotional stress. Much like the 80s Matthew Broderick movie “War Games”, it can be a losing battle where no one wins. Collaborative divorce is instead focused on an open process of problem solving and the development of amicable solutions through the guidance of professionals including attorneys, accountants and divorce financial planners. While collaborative divorce or mediation may save time and money, it is not right for everyone. In particular, collaborative divorce may not be suitable if there is a power imbalance, lack of transparency in financial matters (one spouse has reason to believe the other may be hiding assets/income) or if other forms of abuse exist. However, if both spouses truly want a fair resolution with the least amount of emotional stress, a consultation with an attorney, accountant or financial planner who specializes in collaborative divorce may help.
Having unrealistic lifestyle expectations post-divorce
Many divorcing couples underestimate just how significant the financial impacts of a divorce can be. Remember, it may be impossible to maintain two separate households with the same pool of income & assets that were previously sustaining one. Simply put, post-divorce financial lifestyles can be dramatically lower. According to Leif Pettersen, Certified Divorce Financial Analyst with Independent Wealth Management, “Most couples don't realize that in most cases a reduction in lifestyle is inevitable post-divorce. Planning is crucial to determine where you stand.”
Part of the problem is that couples fail to take the pre & post-divorce budgeting process seriously. This can be especially true if one spouse tends to handle more of the finances. The other spouse may be left in the dark when it comes to understanding household income, expenses and cash flow. Remember, knowing your numbers is critical.
Failing to understand the tax implications
From the tax impact on income and assets to the treatment of alimony or a buyout, tax complications can lurk around every turn of the divorce process when there are significant assets and income to divide. In particular, alimony can be an area of confusion for divorcing spouses. For example, the spouse receiving alimony is sometimes unaware that they will have to pay ordinary income tax on amounts received, significantly reducing the net income available to cover their post-divorce expenses. (The spouse paying alimony receives a tax deduction). On the other hand, the spouse paying alimony or maintenance sometimes offers to buy-out their spousal payments with a lump-sum payment, forgetting that alimony buy-outs may not be tax deductible like traditional alimony payments, ultimately increasing their net costs.
Additionally, the cost-basis of assets being split and the tax impacts of liquidating assets in the future must be considered. Leif Pettersen suggests “Special attention must be given to the complexities of pension plan distribution. While taxes can be a complex topic, it doesn’t have to be overwhelming.” Consider leaning on your team of professionals so that you can get a better handle on the tax implication of your divorce.
Missing social security benefits
For couples married for 10 years or longer, the lower earning or non-working spouse is entitled to receive social security benefits based upon the higher earning spouses record – without impacting the higher earning spouses benefit. This can be an important consideration if you are close to reaching the 10-year threshold as it can make a substantial difference for the lower-earning spouse in the future. Other rules may apply so consider visiting ssa.gov for additional information.
Failing to develop a post-divorce financial plan
Unfortunately, too many couples fail to develop an individual post-divorce financial plan. Leif Pettersen adds, “Financial planning is just as important after a divorce as it is before. A comprehensive look at where you stand in relation to your financial goals may be much different than when married and requires a close examination.” For many couples, divorce can derail many of their financial goals and it is critical for anyone starting over emotionally and financially to develop a “financial Launchpad” for their future. Getting advice at the intersection of your money and your life is critical as it can help bring financial clarity after the difficult process of divorce is complete. Developing a financial life plan can help.
Forgetting to update beneficiary designations and your estate plan
Too often, updating wills, powers of attorney, living wills, beneficiary designations and the like are forgotten after the divorce is complete. It is critical to recalibrate your estate plan to reflect your new post-divorce financial life. Working with an estate planning and financial professional can help ensure that the proper documents are updated and assets are retitled accordingly.
Surrounding yourself with a team of financial professionals that are focused on an equitable resolution rather than conflict may help you to avoid some of the common mistakes couples often make when considering divorce. Since everyone’s situation is unique, consider speaking to your accountant, attorney and divorce financial planner to determine the appropriate approach for you.
Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.