One of the side effects of the coronavirus pandemic has been a big increase in the divorce rate in the United States. The number of people seeking divorces was 34 percent higher from March through June 2020, compared to the same period in 2019, according to Legal Templates, a company that sells legal documents. The Canterbury Law Group reports that 42 to 45 percent of first marriages will end in divorce, as will 60 percent of second marriages.
Planning Is Critical in Protecting Your Retirement Assets in a Divorce
According to the National Institute for Retirement Security (NIRS), divorced people have less money in their individual retirement accounts than the married do. The mean value of independently owned defined contribution accounts is $84,874 for married men and $50,126 for married women in 2020. Those numbers drop to $58,951 for a divorced man and $38,613 for a divorced woman.
Married people also, unsurprisingly, have more retirement money for their households. For example, the mean value of household defined contribution accounts is $136,055 for married men, while it’s the same $58,951 for the divorced. NIRS reports that the elderly poor are more likely to be divorced than married elderly Americans or seniors as a whole.
Divorce can be especially disastrous to women’s finances. The NIRS says women who divorce tend to do worse than men in terms of their retirement savings — especially if they divorce later in life, when their careers are ending.
Planning can help you minimize the negative impact a divorce can cause to your financial situation. In particular, to avoid at least some of the emotional and financial devastation that divorce can cause, avoid these five big divorce mistakes:
Mistake #1: Failing to understand you might be responsible for your ex’s debt
You might still be responsible for your ex-spouse’s debt, even if your name is not on it. In general, both parties are responsible for any debts incurred during the marriage. It doesn’t really matter who spent the money. When the property is divided during the divorce, the spouse who receives the asset is generally also responsible for any loans secured by that asset.
Here’s what that looks like in practical terms. Paul and Tracy were married for eight years. During that time, Tracy ran their credit card to the limit with her compulsive spending. The court held Tracy solely responsible for paying the $12,000 in credit card debt. After the divorce, however, Tracy did not change her ways and was unable to pay off her debt. The credit card companies came after Paul, who ended up paying them off. One solution would have been for Tracy to pay off the credit cards with assets she received when the divorce was finalized or for Paul to have received additional property in the divorce settlement to offset this debt.
Mistake #2: Not considering the value of career assets
Some couples are invested in their careers and earning capabilities instead of building their savings accounts. They might see their careers as being more valuable than tangible assets. As a result, one spouse might have significant assets tied to his or her career. These career assets include the following:
- Life, health and disability insurance
- Banked vacation and sick days
- Social Security benefits
- Unemployment benefits
- Stock options and restricted stock units, or RSUs, a form of stock-based employee compensation
- Pension and retirement savings plans
- Job experience and seniority
- Professional contacts
- Education and training
For example, let’s look at a family in which one spouse is the sole wage earner. Many times, one spouse will put the other through school or help him or her become established in a career. Together, they have made the decision to spend the time and energy to build one career with the expectation that they will share in the fruits of their investment through the enhanced earning power of the second spouse as he or she builds a career.
It is important for you to have your financial advisor conduct a complete financial analysis for you and review your career assets when your attorney and your spouse’s attorney are about to decide on an equitable settlement. Your attorney can advise you about how the court in your state will consider career assets as part of the property settlement.
Mistake #3: Overlooking the tax consequences associated with various assets
There is a tax consequence for just about every move you make with your money. Some assets have a bigger impact on your tax burden than others.
If you and your spouse agree to split assets equally, and some are pre-tax and some are post-tax, the split will not be equal. For example, let’s say you and your spouse have a bank account with $50,000 in it, and your spouse’s 401(k) account at work is worth $50,000. You agree that your spouse will keep the 401(k) and you will get the bank account. Because your spouse will have to pay tax on the $50,000 401(k) account, this is not an equal split. At the time of the divorce, maybe your spouse said, “Let’s just split everything fifty-fifty. You take this half of the assets, and I will take that half. Is that OK?”
Unfortunately, there was something your spouse neither knew nor understood; neither did your spouse’s lawyer, and neither did the judge. They didn’t realize that your spouse would have to pay taxes on his or her half of the assets when trying to access them, while you could access your half of the assets tax-free. The 50/50 split ends up costing your spouse an additional $15,000 in taxes. Had you met with a financial professional before the divorce was finalized, both of you would have been in a better position to come to a more equitable settlement.
This scenario has an unfortunate ending. Pre-divorce financial counseling can help people going through a divorce arrive at a settlement that is fully understood by, and equitable to, everyone involved.
Mistake #4: Being unprepared for the possibility of a post-divorce audit
Just because the divorce settlement is final does not mean the parties are exempt from possible future tax liability. For three years after the divorce, the IRS can perform a random audit of joint tax returns. In addition, the IRS can audit a joint return, if it has good cause to do so, for seven years. It can also audit a return whenever its agents believe fraud is involved.
To help you avoid potential tax liability, make sure your divorce agreement provides for what happens if any additional interest, penalties or taxes are assessed. Also make sure it specifies where the money will come from to pay for costs incurred to hire professionals if there is an audit.
Mistake #5: Not meeting with a CERTIFIED FINANCIAL PLANNER™ or Certified Financial Divorce Analyst® before starting negotiations
A qualified financial advisor can help you reach a more equitable and profitable settlement, avoid unforeseen tax or issues, and support you and your attorney. What good is fighting for the house, only to find out after mediation that you will not be able to afford it or that you haven’t considered all assets? A qualified financial advisor may hold the CERTIFIED FINANCIAL PLANNER™ (CFP®) or Certified Financial Divorce Analyst® (CDFA®) designation. They can provide you and your attorney with data analysis that shows the financial effect of any given settlement. This expert becomes part of your divorce team and provides support on financial issues such as these:
- Understanding the short- and long-term effects of dividing property
- Analyzing pensions and retirement plans
- Determining if you can afford the marital home, and if not, what you can afford
- Recognizing the tax consequences of different settlement proposals
- Deciding on the amount of alimony and/or child support to be paid, if applicable
Divorce is hard enough without getting blindsided by unexpected tax consequences, incurring debt obligations or receiving less than what is fair. Selecting an attorney whom you trust and feel comfortable with and working with a qualified financial advisor can simplify a difficult process. Taking this important step can help everyone reach a more equitable settlement, minimize legal expense by expediting the process, and avoid surprises years after the divorce.
Randy Carver is the president and founder of Carver Financial Services, Inc., and is also a registered principal with Raymond James Financial Services, Inc. Having been in business for over 30 years, Carver Financial Services, Inc. is one of the largest independent financial services offices in the country, managing $1.94 billion in assets for clients globally, as of January 2021. Randy and his team, work with individuals who are in financial transition as a result of divorce, retirement or the sale of a business. You can reach Randy at firstname.lastname@example.org.
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Randy Carver and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of 01/05/2021 and are subject to change without notice. Past performance may not be indicative of future results. No specific tax or legal advice is given or intended. Raymond James and Carver Financial are not affiliated with National Institute for Retirement Security (NIRS), Legal Templates, and Canterbury Law Group.