Planning for a split-up could mean the difference between poverty and solvency. Here's what to do.
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Planning for a split-up could mean the difference between poverty and solvency. Here's what to do.
No one begins a marriage expecting it to end in divorce, but that's what happens to millions of peoplephysicians included. Dividing your money and assets is an emotional issue that can have you hurling pots and fighting bitterly.
"But if you prepare weeks or months before the financial negotiations, at least you can save a substantial amount," says Dan Sears, a divorce-planning specialist in Manchester, MA. "One internist who had a reasonably amicable divorce agreed to split his pension plan equally with his ex-wife after a 27-year marriage. But he and his lawyer didn't pay attention to which stocks and funds went to whom. His ex-wife got the stocks that had been purchased at high prices. Since her tax cost basis was high, her taxable capital gains were minimal. The doctor ended up with the stocks bought at low prices; their low cost basis meant he had substantial embedded capital gains.
"When he rebalanced his new portfolio, he sold a lot of his stock and was hit with a tax bill that drained 34 percent of his net worth. Better planning could have avoided that."
Financial preparation can clarify which arrangements will benefit you most. A child support or alimony arrangement that looks good on the surface may actually be less favorable than a lump-sum settlement, after figuring the future value of money, says Dan Caine, a tax attorney and co-developer of Split-Up divorce planning software. If you calculate and compare financial scenarios, you can analyze their long-term impact instead of being misled by what appears to be equitable.
For example, future college expenses are easy to underestimate. One spouse may project the future cost of college for your two children, ages 5 and 7, based on today's tuition. But the estimate that sounds sizable now may fall short, unless you figure in expected inflation and taxes. "When you do those calculations, people say, 'If I knew it would cost that much, I would have gotten my spouse to pay more toward it,' " says Caine.
Early financial planning can also help you create a better post-divorce lifestyle, says Caine. "People in the throes of divorce may say, 'I just want out, I don't care what we decide.' Months later, they look back and say, 'What did I do?'
"Pre-divorce financial planning might alert you to tone down spending and charging," says Caine. "You'll have less money after the divorce, and if you build up high-interest debts, it may take much longer to pay them off than it would have previously. If you can look five or 10 years ahead financially, you may realize that you can't afford to live in your current residence or buy what you're buying."
Most people leave the financial negotiations to their divorce attorneys. Bad move, says Carol Ann Wilson, a financial planner and president of the College for Divorce Specialists, in Boulder, CO. "Most attorneys are not financial planners. They're knowledgeable about divorce law and negotiation, but they may in good faith negotiate a settlement that has a horrible financial impact down the road."
For the best financial division, consider hiring a Certified Divorce Specialist (CDS), a financial planner with expertise in divorce arrangements. Or look for an attorney who has a financial background or has a financial planner on staff.
Another option is to use divorce-planning software that lets you compare various settlement options before you reach the negotiation stage. One program, Split-Up Basic Bundle (www.split-up.com; $129) includes elements that guide you through financial planning for divorce and your post-divorce life. You enter a proposed settlement amount for each spouse's share of the assets and debtshome, car, cash, pension, mortgage, and the like. The calculations tell you how close you are to your desired overall percentage split.
"It's helpful to try different scenarios, because the magnitude of financial decisions isn't always clear," says Caine. "For example, getting an extra $50 a week in child support may have little long-term impact, compared with getting your spouse to put aside money for your child's education. Or, fighting over who can claim the child-tax credit may be less important than arranging to take the mortgage interest deductions."
Part of your planning strategy should include securing your documentation. Once couples decide to divorce, sensitive financial documents often "vanish" from the house. So if you believe you and your spouse may split up, it's important to make copies of bank records; brokerage, retirement, and investment account statements; and statements of anything kept in safe deposit boxes. Otherwise you may find you no longer have access to the financial information you'll need.
If you think your spouse isn't playing fair, you can hire a forensic accountant to scrutinize all financial records and search for hidden money. Scan the checkbook for large withdrawals.
Watch out for other sneaky moves, too. One doctor's ex-wife had been his office manager. Prior to the divorce, she funneled money away from the business, using bogus bills and accounts. If your spouse has a cash business, he or she could be stashing money in tangible assets held elsewhere, such as a boat.
Once divorce looms, it may be wise to open separate bank accounts and terminate jointly owned credit cards, says Caine. An angry spouse could go on a buying spree and incur large debts, which are still your joint responsibility.
To develop a sound financial plan, you'll need to fully understand what assets, obligations, and options you have. Here are some important steps to take:
Learn the details of your retirement plan. Pension plans differ drastically based on whether you're a practice partner or a salaried or hourly employee. Some plans offer early retirement buyout options or supplemental benefits that may drop off at age 62 or 65. It's crucial to have this information available before the negotiations. If your plan is complex, consider involving a pension expert. After you and your spouse have signed the financial division agreement, it's too late to discuss whether you intended optional parts of the employment benefits to be included.
Determine the best way to value your retirement assets. If your spouse has a defined benefit plan, develop a strategy for determining its future value. That's less clear-cut than the value of a defined-contribution plan, and it can be figured in several ways. Don't wait for your spouse to have the plan's assets valued in a way that best suits him or her.
"In divorces, accountants or actuaries are often called as expert witnesses to calculate the value of defined-benefit plans, and they use different discount rates and rules," says Wilson. "You need to get your own expert to do the valuation with a discount rate that benefits you."
In general, pensions and retirement plans are considered marital assets. In some circumstances, the portion earned before your marriage could also be thrown into the mix. Find out if that's the case in your state, and work that factor into your valuation figures.
Explore different child support and alimony arrangements. Some couples structure an arrangement that sounds logical, but later it zaps the payer because it runs afoul of the child contingency rule, says Wilson.
"Let's say the ex-wife doesn't work. The husband is considering paying her $6,000 a month in alimony until Johnny graduates from high school. At that time, he'll lower the alimony payment to $4,000, because he assumes that his ex-wife will need less help once Johnny leaves home.
"But that kind of arrangement would probably violate the IRS' child contingency rule. According to the IRS, that extra $2,000 the husband was paying while Johnny lived at home will be construed as child support, not alimony, if the change happens within six months of the date Johnny reaches the age of majority," says Wilson. "The husband has been taking tax deductions for the maintenance payments. The IRS will then view the $2,000-per-month as having been child support in all prior years, and it will disallow all the tax deductions."
Compare alimony with a lump-sum settlement. Instead of paying alimony for years, think about whether it might make sense to offer a property settlement in a lump sum.
"A property settlement is a tax-free transaction in a divorce," explains Caine. "Alimony is generally tax deductible to the payer and taxable to the recipient as income," says Caine. "If the two parties aren't in the same tax bracket, the method of payment could make a significant difference.
"Say that one spouse is to receive $50,000. You could transfer that money on Day One as a property settlement, and the recipient will have no taxable income. That makes sense if the recipient is in a high tax bracket. But if the recipient has very little income, he or she could receive alimony over 10 years and would pay very little tax, but the payer would get a pretty significant deduction," says Caine. "Explore the variables and tax ramifications before you determine which is best."
Share money now rather than later. If you project your post-divorce financial needs, you may be able to make arrangements to better accomplish your goals.
For example, say you're planning to split your spouse's 401(k) equally, and you'll get $300,000 as your share. "During a divorce, you're allowed to take some of that money prior to age 59 1/2, without paying the 10 percent penalty," says Wilson. "Let's say you need $80,000 to purchase a condominium. Before you sign the separation agreement or financial division papers, you can ask for $100,000, get $80,000 (because 20 percent will be withheld to cover any taxes owed), and avoid the $10,000 in penalties you'd pay by taking the money out after the divorce. If you know how much cash you'll need, you can use it in your planning."
Get maximum tax benefit from your home's appreciation. Assuming you and your spouse are divorcing amicably, you can arrange matters so that you both benefit financially from selling your house.
"If a couple has lived in a house for many years, the appreciation may be substantial," says Wilson. "Normally, with a divorced couple, one person can take the $250,000 tax exclusion on the gain. But if the parties arrange things properly, they can take the $500,000 exclusion that married couples are entitled to, so each gets half.
"As long as both parties lived in the house for at least two years, and at least one of the two owned it for at least two years, they can take this exclusion, even if one party has since moved out. True, they will have to continue to own the house jointly until they sell it, and the settlement must say so. But they can plan to both obtain maximum benefit," says Wilson.
"Other housing issues bear looking into," says Caine. "For instance, if one spouse continues to pay the mortgage but no longer lives in the house, that spouse may only be able to deduct half of the interest, depending on how their arrangement is structured. Many people don't realize this." Researching the financial ramifications of your divorce will help you prevent such costly snafus.
While forging an acceptable settlement, you can rack up major legal fees. Rather than have dueling lawyers, some folks use a divorce mediator or arbitrator to keep costs down. Mediators or arbitrators act as neutral agents. Their fees are usually lower than attorney fees, ranging from about $100 to $350 per hour, although they can go higher. Typically, you don't have to pay a retainer; you can pay as you go.
Mediators help couples negotiate, and can defuse some of the emotional minefields that prevent agreement. The resulting agreements are not binding, and a mediator can't enforce the agreement.
Mediation works best if both parties are operating in good faith, not lying about finances.
In most states, mediators aren't licensed, and there are no set standards for a mediator's education or experience. Some mediators are also attorneys, accountants, or mental health professionals, so it's important to find out a mediator's background and credentials. The mediator accrediting certification process differs by state. You can find out more about the mediation process and get mediator referrals at www.mediate.com.
Arbitrators act like judges and in most cases make decisions that are binding and enforceable. Since the arbitrator may make decisions that you don't like, it's important to find one whom you trust and feel comfortable with.
Look for someone with credentials and training. No national organizations have accreditation programs, but some state organizations may offer them. Arbitrators who are attorneys tend to be more expensive than mediators, but you're still likely to pay less if you sit with your spouse and flesh out an agreement rather than going through a legal battle.
If you're using a mediator or arbitrator, do plenty of homework on settlement options before embarking on negotiations. It's wise to have in mind the minimum amount you'll agree to and the maximum you could hope for prior to your discussions. Find out in advance whether the mediator or arbitrator will be able to educate you on legal points pertaining to your settlement arrangements.
Lawyers can be critical in divorce proceedings. You absolutely need one if you expect a hostile battle, you think your spouse won't cooperate, or you fear he or she is so bent on revenge that logic won't prevail. It's also good to have a lawyer if you'll need someone to stand up for you, particularly if the other party is misrepresenting the facts or the situation.
Leslie Kane. D-I-V-O-R-C-E needn't spell financial ruin.
Nov. 21, 2003;80:45.