Divorce Articles
| This article was first published in the California Divorce Magazine and is reprinted here
with their full permission. |
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Avoiding
Financial Disaster
Here are some tips to help you avoid some of the common
financial pitfalls of divorce.
By Nancy Kurn, CPA, CDFA, JD, LLM, MBA
Many couples face financial uncertainty after they divorce.
This is often the result of using the same income to pay expenses to operate two
households instead of one. For instance, you're now faced with two mortgage or rent
payments; utilities, furniture, appliances, and supplies for two homes...The expenses add
up.
If only one ex-spouse works outside of the home, then he or
she may have to pay both spousal and child support, which will negatively affect the
payor's cash flow. If both spouses work outside of the home, then each would have only a
portion of their combined income to use to pay for their individual household expenses.
Separation or divorce is a time when both of you should
reduce your spending and make an effort to live within your individual means. For
instance, if you're not working, can you really afford the country-club dues or fresh
flowers every week?
One common pitfall is considering the assets that you
receive as part of the property settlement as an additional source of income. Instead of
using these assets to pay for current expenses, they should be maintained for emergencies,
retirement, creating new sources of income, and other long-term financial goals.
This does not mean that you should never touch these
assets: it's one thing to use them to pay for tuition to improve your job skills, but
quite another to deplete them to purchase a brand-new SUV. Before you dip into these
assets, ask yourself whether the expenditure is going to create income for you in the
future, or whether it's a frivolous purchase you're going to regret when the bill comes
due.
Let's take a look at an example of how failing to create
and stick to a realistic budget post-divorce could affect your future.
The Grasshopper and the Ant,
Post-Divorce
Consider the cases of Lisa and Teri: two sisters who
married men with very different careers. Lisa's husband became a wealthy stockbroker,
while Teri's husband worked at the local GM plant. Eventually, both couples divorced.
Lisa was awarded five years of alimony at $75,000 per year,
half of her husband's retirement account ($300,000), and the million-dollar family home.
Lisa was not used to living on a budget of $150,000 a year, and she wanted to preserve her
image as a successful woman. For her, that meant country-club fees, $25,000 a year on
clothes, vacations in Palm Springs, lavish parties, summers in Europe, and keeping the
family home. Her alimony did not come close to covering her expenses, but she dipped into
her retirement account to cover the monthly shortfall. Five years later, she has burned
through her retirement savings, her support has ceased, and her only asset is the house
that she cannot afford.
Teri, on the other hand, received $20,000 per year in
alimony for the same five years plus $35,000 in retirement savings. She went back to
school, which enabled her to get a better, full-time job before her support ended. She
also put herself on a strict budget -- which included $100 a month of "fun
money" to spend on eating out, movies, or to save toward a bigger-ticket item such as
an entertainment center or a vacation. Five years later, she has grown her retirement
savings to $100,000 and is enjoying the same lifestyle as before her divorce.
Lisa ended up with a better divorce settlement than Teri,
but Teri is now in a much better position than her sister. Why? Aside from her obvious
extravagances, Lisa's biggest mistakes include the facts that she:
- did not reduce her expenses, and she lived far above her
means with no plans for ever bringing her expenses into line with her income;
- kept the family house instead of buying a smaller place and
investing the difference;
- spent her retirement savings instead of investing it;
- did nothing to prepare herself for the day her alimony would
end, such as going back to school or trying to turn one of her talents into a business: as
a professional party-planner, for instance.
Not all Assets are Equal
When you are deciding on what assets you and your spouse
will take, you should be aware that not all assets are equal. One of you may end up with a
huge tax bill when you access the assets: for instance, you could end up paying
capital-gain taxes upon the sale of your home or your investment assets. In addition, if
you dip into your retirement assets, you may end up paying income tax and a penalty. In
the example above, Lisa paid taxes and a 10% penalty in the U.S. every year that she
dipped into the retirement account.
Other assets may end up being a money pit. Your primary
residence, vacation home, or rental properties could cost you a significant amount of
money to maintain. Frequently, the primary benefit of a rental property is not necessarily
cash flow, but the tax losses that are generated. If you are in a low tax bracket, then
these losses may not benefit you to the extent that another investment would. Your
expenses may actually increase. For example, if your spouse used to make all repairs, mow
the lawn, etc., but now you have to hire someone to do those things, then your expenses
will increase. Would you be better off liquidating these properties and investing the
proceeds in something that would increase your cash flow instead of creating a financial
drain?
The Family Home
Reducing expenses may mean selling the family home and
downsizing to a smaller home. In the example above, did Lisa really need the
million-dollar family home? In this case, "keeping up appearances" cost her a
comfortable future. If she had sold the house at the time of her divorce, she could have
increased her cash flow in two ways: decreased costs, and additional funds to invest. The
costs to maintain her home -- such as property taxes, utilities, maintenance, and repairs
-- would have decreased in a well-maintained but more modest property. In addition, since
there was no mortgage on her home, she would have been able to buy a smaller home free and
clear and still have funds left over to invest and increase her cash flow.
Her choice to keep the house also meant that she was hit
with all the capital-gains tax from the time she and her ex-husband bought the house in
1975 to the time she was forced to sell it. The house had appreciated significantly in
value over the years, so after paying her tax bill, she was left with a much smaller nest
egg than she had expected to help her start over.
Choose Your Battles
You can go broke during property division if you insist on
fighting over every last item. During her marriage, Mary purchased a leather
desk-accessories set that included a matching leather wastepaper basket. Her husband Larry
wanted the wastepaper basket, but she insisted that the set would be incomplete without
it, so they ended up fighting over it. After spending in excess of $5,000 in attorney's
fees, Mary ended up with the wastepaper basket. Does this sound too ridiculous to be true?
Be warned: this kind of thing happens every day in divorce court. Emotions are running
high, and some people will fight "to the death" over truly trivial items.
Sometimes, they're more concerned with making sure their ex-spouse doesn't get something
than with actually getting it themselves.
You have to look at the big picture. Is this item really
worth fighting over? Can you purchase a new one for significantly less than you will spend
in attorney's fees? Not only are you wasting money, but you are also increasing the
ill-will between you and your soon-to-be ex. If you have children, this can take an
emotional toll on them.
Here's a hard truth for you: no one gets everything they
want in a divorce settlement. You will have to give up some possessions you really like --
maybe even some heirlooms -- so prepare for this by creating a short list of
"Must-Haves," a longer list of "Would-Like-to-Haves," and a third list
of "Don't-Wants." Don't tell your ex you don't want the items on this third
list; instead, "gracefully" offer to trade them for the items you really want.
Be prepared to give up some of your "Would-Like-to-Haves" in exchange for more
of your "Must-Haves."
Forgettable Assets
Some assets are easy to forget, such as pensions, stock
options from an employer, accrued sick and vacation pay, the cash value of insurance
policies, frequent-flyer miles, prepaid dues (such as annual country-club dues and
season's tickets or passes), and timeshare properties and vacation clubs. These should be
addressed as part of the property settlement. In many cases, pensions can be worth more
than houses, so make sure you have a qualified financial professional value these and
other assets before you sign away your rights to them.
Credit Rating and Debt
It is imperative to protect your credit rating. Here are
some tips:
- get a copy of your credit report
- close all accounts that you do not use
- if you don't already have one, apply for a credit card in
your name only
- close all joint accounts and credit cards.
A vindictive or spendthrift ex-spouse can incur debt on
your joint accounts and destroy your credit rating during the divorce process. If you're
not able to pay off a joint account in full, ask if you can maintain a balance on it after
it's been closed.
Your credit report will help you discover any outstanding
debts that need to be addressed as part of the divorce process. It may be best to pay off
joint debts with marital assets, and then each spouse can move forward with a clean slate.
Once your divorce is final, you should use your credit
cards sparingly. If you need to establish a credit rating, make sure to pay off all
balances on time every month.
If you need to use credit for short-term
liquidity, then you may be better off refinancing your home and avoiding maintaining a
balance on your credit cards. The benefits of refinancing your home include deductibility
of interest and a lower interest rate. You will need to qualify for the mortgage, but
spousal and child support are generally included as sources of income to permit a
non-working spouse to qualify for a mortgage.
Back to Work or School?
You may have to go back to work to supplement
your support payments. If you don't go back to work now, do you want to wear a fast-food
restaurant uniform when you're in your 60s or 70s? Your property settlement assets should
be kept for your retirement -- remember Lisa's example (above) when you're tempted to dip
into your retirement account.
You have to be realistic about any career
changes you make. What are your prospects at your current job? If you go back to school,
what can you realistically expect to earn? Will your degree improve your earning capacity?
Are you taking courses that will help you secure a position in a growth industry that
needs qualified workers, or are you just taking a course because it interests you? Does
your chosen career or course of study take advantage of your natural strengths, abilities,
and interests? Taking courses you hate to secure a job you'll hate is not a wise use of
time or money. Work with a career counselor or personal coach to figure out the pros and
cons of staying put or changing direction.
The Bottom Line
Your lifestyle will change after your divorce.
You will have to make some sacrifices. However, if you plan ahead, these sacrifices will
pale beside how bright and prosperous your future will be.
Tips: Avoiding Financial Disaster
- Negotiate a reasonable settlement. Get some
professional advice from a CDFA or CFP to make sure you'll be able to live with the
financial terms of the settlement -- now and into the future.
- Don't live beyond your income. Reduce your expenses
-- or increase your income -- so that you are always saving something for a rainy day. Ask
your financial advisor for help creating a budget if necessary.
- Think twice about keeping the family home. Ask your
financial advisor whether you can truly afford it, and ask them to show you what cash
you'd have available for investment if you moved to a smaller home.
- Realize that you won't get everything you want in the
property division. Don't spend months and thousands of dollars fighting over
furniture, appliances, or other personal items. Make a short list of
"Must-Haves" and be prepared to compromise on everything else. Look at the big
picture; is this asset best for your situation?
- Protect your Retirement Assets. In the U.S., have the
QDRO filed as soon as possible. In Canada, make sure to have the pension valued by a
qualified professional.
- Use debt sparingly. Get a copy of your credit report
and close all joint accounts and all credit you do not use. Avoid maintaining balances on
credit cards.
Nancy Kurn (JD, LLM, CPA, MBA, CDFA) is the
director of Educational Services for the Institute for Certified Divorce Financial
Analysts.
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