Taking care of Financial matters after Divorce
May 24, 2010
Taking Care of Financial Issues After Divorce
Michelle Ash offers the following advice for women on how to handle various financial issues after divorce, something that is often over-looked.
Financial and Estate Clean-Up After Divorce
The divorce is finally over, the decisions have been made, and now life proceeds anew for the client. But it’s never really that easy, is it? For the newly-divorced client, the legal work may be done, but there’s often a long list of financial clean-up that lies ahead.
There are the “big rock” items, such as home refinancing, re-titling of homes and cars, retirement asset division – all the stuff that’s mentioned in the divorce documents themselves. And there are smaller, but also important, items such as removing the ex-spouse from credit cards, bank accounts, gym memberships, and so forth.
But there is also an underlying category of items of equal, or perhaps greater, significance that often are forgotten – until it’s too late. These items control where assets will go when a client passes away, and given the emotional turmoil accompanying most divorces, many clients and families alike will agree that the last person they want to bequeath assets after death would be the former spouse. Yet all too often, this is what happens as divorced individuals move ahead with their new lives, avoiding the pain of their recent divorce with that common enemy of resolution – procrastination.
First, let’s list the important items a client may want to consider amending:
Beneficiary designations for the following financial instruments:
- Employer Retirement plans
- Individual Retirement Accounts (IRA)
- Life insurance Annuities
- Health savings accounts
- Transfer on Death (TOD) investment accounts
- Payable on Death (POD) bank accounts
- Will
- Health care powers of attorney and living wills
- Powers of Attorney
- Revocable trusts
- Advanced estate planning structures such as irrevocable trusts
Since the spouse is usually the individual selected to receive or inherit property controlled by these documents and instructions, many, if not all, of these items will need to be amended.
Amending the Beneficiary
The items above are listed in the general order of difficulty to amend. A beneficiary designation can be very simple to change. Typically these changes simply involve the client obtaining the proper form, completing it, and putting it on file so their request is documented. The same is true for Transfer on Death (TOD) and Payable on Death (POD) accounts an individual may hold at an investment firm or a banking institution respectively. Having said that these arrangements are the easiest to amend, they are also the easiest to forget, since the assets controlled by these accounts may not have changed as a result of the divorce.
This danger applies particularly for retirement accounts – employer plans such as 401(k)’s and 403(b)’s, and Individual Retirement Accounts (IRA’s). Retirement arrangements and employer plans often represent a significant portion, if not the majority, of a client’s net worth and liquid assets. Since assets passed to a named beneficiary pass under operation of contract, this designation supercedes the client’s will and state intestacy statutes.
According to estate planning attorney C. Randolph Coleman of The Coleman Law Firm, “There usually are a half dozen cases during a typical year where someone will call and ask whether there is anything they can do to avoid the ex-spouse of their recently deceased spouse, parent, child or sibling, from taking the life insurance or retirement plan that the ex-spouse was still the beneficiary designated on the decedent’s plans/policies. The short answer, there is nothing you can do. The beneficiary designation will trump the will or intestacy every time.”
Wills, health care documents, and powers of attorney all require more time and expense to amend, as the client should likely seek legal counsel for assistance with these items. Despite the additional cost, these documents should be high on a priority list for a divorcee, particularly those who are parents of minors, as the will governs who will care for their children in the event of death, and the health care documents dictate how the clients are cared for in the event of incapacity.
Handling Trusts
Revocable trusts, often known as Living Trusts, are more complex in their drafting and may require further consideration, as the client may need to amend beneficiaries and/or trustee powers to eliminate the former spouse. Finally, advanced estate planning structures such as irrevocable life insurance trusts (ILIT’s), Qualified Personal Residence Trusts (QPRT’s), and charitable trusts may be very difficult, if not impossible to amend, since the original intent of creating these structures was to make an irrevocable election, usually structured to benefit both husband and wife together. Should the husband or wife assume the power to change the irrevocable election, the tax advantages gained by the structure may be undone. The client will need to work closely with his or her attorney, as well as trustees, to explore possible options.
Who to leave your estate to after divorce
Aside from clearing up the issue of outdated documents, the newly divorced individual has another problem to solve: who to leave their assets to now that the former spouse is most often not the desired heir. If a divorcee has adult children, this issue might be easily solved, as the parent often desires to leave any assets to their grown children. In the case of minor children, however, the choices can be confusing and problematic.
If you leave assets to your minor children
The typical desire a parent expresses is to leave assets directly to the minor child. Unfortunately, should the parent pass away while the child is still a minor, this choice will result in the court appointing a guardian to oversee and dispose of the assets, costing both time and money the parent likely did not plan for.
Another problem with this choice is the issue that the guardian, with extensive court oversight, now must determine how the assets will be managed, and what will or will not be purchased with those funds. These decisions may or may not be in alignment with the choices the parent might have made. Many times a divorced parent, looking for the path of least resistance, will simply say, “Won’t the courts choose (their choice of guardian) to manage the asset?” assuming inherently that the court would make the same choice he or she would make. The short answer is, not necessarily. Just because a person seems to be the best choice to the parent, does not mean the courts will see things the same way. If a parent has a wish for who will manage an asset, the parent needs to specify it in legal documents.
A single or divorced parent might then say – if I cannot leave the assets to my child, I’ll just leave them directly to the adult I want to have manage them for my children — my parents, sibling, aunt/uncle, or family friend. This decision could also prove to be problematic.
Leaving your assets to the children’s guardian
Leaving the assets to the adult guardian causes that person to be entirely in control of those assets – with unrestricted rights to the assets – as well as potentially putting those assets up for grabs by that person’s creditors in the event of financial difficulty. If Jane Doe leaves a $100,000 life insurance benefit to her brother, Jim, that money now belongs to Jim – and potentially, his spouse, children, and creditors. Jane may feel certain that Jim will use the assets for the care of her children, but there is no legal arrangement that requires him to do so. If Jane puts this arrangement in place and then does not die until her children are adults the situation may be even worse. Unless she amends her estate plan, she will have unintentionally disinherited her children.
Some parents might throw up their hands and decide just to leave their financial fate to the laws of intestacy, thinking that their children will end up with the assets, or their benefit, in the end. While this might be true in theory, the average probate proceeding lasts nine months. The children will receive some care in the meantime, but the caretaker will not have the benefit of the majority of the financial resources during that time. This shortfall may cause the child’s life and activities to be drastically altered, further compounding the loss of the parent.
What if you get remarried?
Perhaps the newly divorced parent has a significant other in his or her life, and remarries. Here again, the parent may unintentionally disinherit a child, as without legal documentation to indicate otherwise, a spouse is generally entitled to one half of the deceased spouse’s estate. The second spouse may not be the resulting caretaker of the former step-children, yet has received half of the assets intended to provide for them.
The divorced parent may desire to leave assets to care for both the new spouse, and the children. In such a situation it may be very important for the parent to sit down with a financial advisor or their estate planning attorney to assess their options. An easy solution is the use of additional life insurance to assist the parent in their wishes to provide for both the care of minor children and the new spouse. Term insurance can be a low-cost solution to provide these benefits until the children reach adulthood, assuming the parent is insurable.
The importance of estate planning after divorce
This quagmire of follow-on hypothetical situations may seem overwhelming. So, what’s the most streamlined approach to take to this situation? First, use the list of follow-on items to amend, and focus initially on the easy items to complete, in particular those overriding beneficiary designations. Second, consider seeking assistance from a qualified estate planning attorney or financial advisor specializing in estate planning. A divorced individual can use these resources to get the detailed advice needed, and follow-on assistance to get the job done.
Again from estate planning attorney, C. Randolph Coleman, “I probably see about 6 or 8 people a year who typically come in for estate planning 4 to 5 years after a divorce to ‘finally get around’ to updating their estate planning. Usually, during the course of our discussions I will suggest to them that they go back to their employer and check on the beneficiary designations for their life insurance and retirement plans. Invariably, about half of them will call back and tell me how much they appreciate the counsel to check because their ex-spouse remained their beneficiary.”
Copyright 2007–Michelle Ash is a Certified Divorce Financial Analyst™, Certified Financial Planner®, and Managing Partner of Paragon Wealth Strategies in Jacksonville, Florida.
Trendline Financial Solutions is a Financial Planner Firm offering Financial Planning and Investment Management with offices in Southold, Great Neck and West Hempstead, NY – convenient to Garden City and Rockville Centre specializing in life changing events such as Divorce, loss of loved one, arrival of new baby.
Peter Owen is President and Chief Financial Planner
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Common financial mistakes in Divorce
May 23, 2010
Divorce Settlement Considerations
As you consider your divorce settlement, you may be tempted to sign it just to get things over and done with. This is a bad mistake. Even if everything looks fair and equitable, you may not really be getting a good deal. Below is an article by By William Donaldson, that outlines some major areas to consider in your divorce negotiations.
Divorce and Your Finances – The 7 Most Costly Mistakes
Each year there are nearly 1 million divorces in the United States, or about 50% of all marriages (2002 United States Census Bureau statistics). The real tragedy, however, is the financial devastation that occurs to many individuals after their divorce.
Too often, a divorcing individual accepts an unfair settlement and finds that a few years later he or she is experiencing serious financial challenges. Was he or she intimidated or pressured to settle? Did the offer appear to be equitable? What ever the reason, this outcome can be significantly improved upon, if not altogether avoided, if you first understand the seven most costly financial mistakes commonly made in divorce settlements.
Following are brief summaries of these seven mistakes. Each of these areas can be quite complex, so we strongly recommend that you consult a professional prior to making a financial decision that may affect the rest of your life.
This list is not exhaustive, and depending on the complexity of your case, there may be many more areas that require thorough analysis.
Mistake #1: Not Knowing the Liquidity of Assets
Liquidity refers to the ability to access the cash value of an asset. For example, a bank savings account is highly liquid, because you can simply withdraw funds from an ATM when you need them. An antique automobile, however, is nearly illiquid because it is very difficult to quickly sell this asset to access the actual cash value.
Often in a divorce settlement, one party will receive mostly illiquid assets, including the home, while the other party receives liquid assets such as retirement plans, brokerage accounts etc.
What is the potential problem with this type of settlement?
On the surface, this scenario may appear to be equitable assuming that the home and other assets are of approximately the same value. However, the challenge lies in cash flow. How will the party that keeps the home pay the bills if his or her major asset is illiquid?
One can borrow against the equity of the home, but that’s costly (closing costs, interest etc.) and it takes time to close the loan. In worst-case scenarios, the home must be sold, a smaller home is purchased and the remaining equity is utilized for living expenses.
If your proposed financial settlement has very little liquidity, be sure that you will have enough cash flow throughout the years to handle your living expenses. If not, you may have to consider selling the home, other assets or significantly decrease your expenses in order to meet your budgetary needs.
Mistake #2: Failure to Consider the Impact of Taxes
The effect of your settlement on various taxes can be very costly if not addressed thoroughly. Capital gains, income tax, and alimony are just a few of the areas that may be impacted.
Capital gains taxes need to be analyzed when property is being divided. Capital gains refer to the fair market value of an asset minus its cost. For example, if you paid $5 for a share of stock and it is now worth $25, you have a capital gain of $20. This applies to other assets such as real estate (including your home), mutual fund accounts and just about any investment that has appreciated in value.
Be very careful that the property you are receiving in a settlement does not have large capital gains as compared with your ex-spouse’s property. Don’t be fooled if your spouse offers you property of equal value but conveniently forgets to inform you of the tax liability.
As an example, you may be offered an investment account worth $150,000, but the cost basis is only $50,000. That means there is a gain of $100,000 that you must pay at minimum long-term capital gains tax (15% in 2004). There could possibly be short-term gains as well, which are taxed at your own marginal tax rate (as high as 35% in 2004).
In the case of your personal residence, the federal government eased the tax burden in 1997 by allowing a $250,000 capital gain exclusion per spouse if you’ve lived in your home for at least 2 of the past 5 years. If the home is to be sold and there is a considerable gain in value (over $250,000), you should consider selling before the divorce to take advantage of the full $500,000 exemption.
If you had sold a home prior to 1997 and rolled over the capital gain to the existing home, the old rules will apply to determine the cost basis of the current home. This will increase your gain and possibly further the need to sell while still married.
Income taxes are effected primarily by alimony payments and filing status. Alimony received is taxable as ordinary income, so a $50,000 payment received is actually worth $35,000 after taxes, assuming a 30% marginal state and federal tax bracket.
On the other hand, the payer of alimony receives a tax deduction, so the same $50,000 payment actually costs the taxpayer $35,000 assuming the same tax bracket.
Filing status is an important decision after the divorce. If you were still married on 12/31 of the tax year, you have the option of filing a joint return. If you can peacefully deal with your spouse after the divorce, you should consider this option as it could save considerable tax for both parties.
If you were divorced after 12/31 and you qualify, filing as head of household versus single can also save considerable tax dollars. Your best course of action is to consult with a tax professional regarding these options.
Mistake #3: Not Understanding the Rules of Retirement Accounts
Retirement accounts are a tax related issue, but their complexity merits a separate category. If a large portion of your settlement consists of retirement assets, you need to be aware of the many tax ramifications and potential penalties involved.
QdroDesk – is an online service providing divorcing spouses with an instant, easy, accurate, and affordable method for obtaining Qualified Domestic Relations Orders (QDROs), the appropriate settlement agreement language, and processing instructions to divide a retirement account upon divorce. Combining 45 years of expertise with a smart question and answer technology, QdroDesk has easily become the ideal solution for QDRO preparation.
Normally, distributions from a retirement plan prior to age 591/2 are considered “early distributions” and are subject to a 10% penalty tax as well as ordinary income tax. An exception to this rule, however, is a transfer to an ex-spouse as part of a divorce settlement. A Qualified Domestic Relations Order (QDRO) is used to affect this transfer. Income taxes still apply, so any assets you receive from a “qualified plan”, such as a 401(k), will be subject to a mandatory 20% tax withholding. For example, if you are awarded a $100,000 distribution from an ex-spouses 401(k) you will actually receive only $80,000.
To avoid this mandatory withholding, the transfer must be made directly to another retirement account, such as your own IRA. Once the assets are in your retirement account, you are now subject to the early distribution rules. If you need some of the assets to live on, or pay bills, make sure you take them out prior to transferring them to an IRA to avoid the 10% penalty.
To simplify, let’s look at an actual example of how this transfer works:
- Barbara and Stanley are both age 55 and going through a divorce. Stanley has $560,000 in his 401(k) that will be divided by a QDRO, transferring $280,000 to Barbara.
- She could transfer the money directly to her IRA and pay no taxes until she starts withdrawing funds after age 591/2, at which time she would pay ordinary income tax on the amount withdrawn. But Barbara needs $80,000 for a down payment on a new house. So she holds back $100,000 before transferring the remaining amount to her IRA. 20% is withheld for taxes, leaving her with $80,000 to spend without incurring a 10% penalty.
- After she transfers the remaining $180,000 to her IRA, Barbara is held to the early withdrawal rule. If she says, “Oh, I forgot, I need another $10,000 to buy a car,” it is too late. She will have to pay the 10% penalty and the taxes on that money.
It is important to note that IRA’s are not qualified plans, so a QDRO is not needed to divide the assets. Also, there is no 20% mandatory tax withholding on a transfer. To avoid paying taxes, you must deposit any distribution from an IRA directly to your own IRA. If a check is sent to you, you must deposit the money into your own IRA within 60 days to avoid a taxable distribution.
Mistake #4: Overlooking Debt and Credit Rating Issues
Nothing is worse than starting out a new life with bad credit. Several steps can be taken during the divorce process to minimize the chances of this occurring.
First, obtain a copy of your credit report. This will identify all joint accounts, accounts you may not have been aware of, and any potential credit problems.
Next, be sure to pay off and close all joint accounts prior to the divorce settlement and open new accounts in your own name. Unfortunately, creditors don’t care how a separation agreement divides responsibility for joint debt (joint credit cards, auto loans etc.). Each person is liable for the full amount of debt until the balance is paid, hence the importance of dealing with this issue prior to your divorce.
Regarding income tax debt, even if the divorce is final, you may not be exempt from future tax liability. For three years after the divorce, the IRS can perform a random audit of a divorced couple’s joint tax return. If it has good cause, the IRS can question a joint return for seven years.
To avoid any potential problems down the road, your divorce agreement should have provisions that spell out what happens if any additional penalties, interest or taxes are found as well as where the funds come from to pay for any expenses associated with an audit.
Mistake #5: Not Maintaining Control Over Insurance Policies
Most divorce decrees call for one of the parties to obtain a life insurance policy to insure the value of alimony payments, child support or some other financial need. If you are the person for whom the insurance is obtained, it is critical that you are either the owner or irrevocable beneficiary of the policy.
If you are not, the ex-spouse who took out the policy could easily stop making payments and you would never know about it until the policy is needed and it no longer exists. This could be financially devastating. As the owner or irrevocable beneficiary, you would be notified of any outstanding issues with the policy, such as non-payment of the premium, and could therefore take action and prevent the policy from lapsing or being cancelled. Read more about Divorce & Life Insurance Considerations.
Mistake #6: Failure to Budget
One of the most common mistakes made post-divorce is the failure to budget based on one’s new lifestyle. We see this happen most often when one spouse keeps the home for the sake of the children or perhaps due to an emotional attachment. Because of the high value of the home, there are few other assets awarded in the settlement. The expense of maintaining the home and the lack of liquid assets often results in a rapid depletion of cash, leaving no choice but to sell the home.
This scenario can be avoided if you take a good hard look at your expenses versus liquid assets and income. A Certified Divorce Financial Analyst can help you project several years into the future and determine if you’ll have enough resources to support your current lifestyle as well as your retirement years.
This analysis should be completed prior to a settlement. If it is determined that you will be unable to maintain your lifestyle with the proposed offer, you have established a good case to request more assets, alimony or child support.
Mistake #7: Failure to Identify Hidden Assets
Hopefully, you’re not in a situation where you distrust your spouse and fear there are hidden assets that should be included in the settlement. Unfortunately, once a divorce is initiated, many individuals will do whatever they can to preserve what they feel is their own money. Some individuals maintain secret accounts or other financial activities throughout an entire marriage. If these assets are not exposed, one spouse is certain to obtain an unfair settlement.
There are multiple resources and methods used by financial professionals and attorneys to uncover potential hidden assets. Being aware of these may help you avoid being victimized by a dishonest spouse. Forensic accountants are generally the most commonly utilized professionals to assist in this area.
- Tax returns are one of the best places to start. Most people are uneasy about misleading the IRS for fear of penalties, fines and even prison. Go back at least 5 years to look for any inconsistencies in income, the presence of trusts, partnerships or real estate holdings. (Learn about Getting A Copy of Tax Return Information for previous years)
- If your spouse is a business owner, corporate or partnership returns may show a change in salary, charging personal expenses to the company, or excessive retained earnings. Another common trick is to put a “friend” on the payroll, who agrees to give back the money paid to him after the divorce. A forensic tax professional is of tremendous help in this area.
- Checking account statements and cancelled checks for the past few years can also be quite revealing. A cancelled check for a purchase you never knew about, such as an investment property, can make a substantial difference in total assets to be divided.
- Savings accounts may reveal unusual deposits or withdrawals in amount or pattern that could point to a hidden asset such as a dividend producing investment. In addition, cash may be hidden almost anywhere.
- Brokerage statements are valuable in tracking the purchase and sale of securities. If securities are sold and the proceeds are not accounted for, you can be sure that the assets are out there somewhere.
- Expense accounts can be abused when corporations give employees a great deal of leeway in their expense account reporting. Cross checking between expense account disbursements and savings/checking account deposits may indicate a pattern of abuse if the deposits exceed legitimate business expenditures.
- Children’s bank accounts may be opened as a custodial account for the intent of hiding assets as well. In some of these cases, interest is not reported as income on tax returns, and no return is filed for the children.
This is not an exhaustive list of places to look for hidden assets. If you suspect this is occurring, you owe it to yourself to seek help from a financial professional or forensic accountant.
In Summary
There are thousands of articles, books, manuals and other publications written about the financial issues of divorce. It is a complex area, and certainly deserves the attention it gets.
But reading this article or any other resource will probably not make you an expert. If you think you may not be receiving fair treatment, or you are simply uncomfortable dealing with these issues, it might make sense for you to consult with a financial professional who is trained specifically in divorce related issues.
A Certified Divorce Financial AnalystTM (CDFA) has endured extensive training in the financial issues of divorce. He or she will analyze the long-term financial impact of a proposed settlement and help you determine if it is feasible. Remember that a proposed settlement might look fair initially, but without proper analysis and forward looking projections, it can lead you to a future of financial hardship.
The bottom line is don’t settle until you know how it will affect your financial future!
Article submitted February 2005 by William Donaldson and Adam Westphalen, Certified Financial PlannerTM professionals and Certified Divorce Financial AnalystsTM
Trendline Financial Solutions is a Financial Planner Firm offering Financial Planning and Investment Management with offices in Southold, Great Neck and West Hempstead, NY – convenient to Garden City and Rockville Centre.
Servicing all Nassau County villages:
May 2010 Trendline Financial Monthly
May 7, 2010
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