According to Bloomberg, the divorce rate has dropped 18% in 2018 in large part because Generation X and Millennials are staying married. By delaying marriage until later in life after education and careers have been established and finances are on track, the younger generations are changing the divorce rate in the United States. But even with a dropping divorce rate in recent times, it still happens and is an emotionally and financially trying event for many people.
With any divorce often comes emotionally-charged negotiations and the inevitable splitting of assets. From a financial perspective, it can be hard to remain objective and advocate clearly for yourself under such stressful and upsetting circumstances. Yet, what is decided in a divorce settlement lays the foundation for the new chapter you will begin after everything is said and done, signed, and filed.
Whether you think divorce is something that may affect you in the future or someone you know, avoiding certain financial mistakes during a divorce settlement can be the difference between being set up for success or failure in the weeks, months, and years following a divorce.
Here are five frightening financial mistakes to avoid at all costs in a divorce settlement.
Not Being Aware of the Household Finances
If you are not currently aware or involved in the household finances, now is the time to start making yourself intimately aware. Ideally, you want to go into a divorce settlement with eyes wide open when it comes to the finances. You’ll need to know your and your spouse’s monthly overhead, income, any outstanding debts and tax liabilities, balances and locations of all retirement accounts, investment accounts, and what is available in checking and savings. Furthermore, make sure you have access to all of these accounts with your own login details and administrative access.
Know your net worth, your spouse’s net worth, and your combined net worth. Traditional gender roles that often result in the woman assuming caretaker responsibilities for children and aging parents contributes to lower lifetime earnings overall and less Social Security benefits according to Chris Chen, Certified Divorce Financial Analyst and CEO of Insight Financial Strategists in Waltham, Massachusetts.* So, you’ll want to make sure you can negotiate the best terms for your financial well-being. I know this can sound tedious and even a bit overwhelming if you never involved yourself with money before, but these are all the facts and figures you’ll want to be sure you understand to protect yourself during a divorce.
Not Setting Yourself Up to Win Financially
During times of stress and grief, it can be extremely difficult to force yourself to think about, and maybe even care about, the future. But the truth is, this too shall pass. One day, even though it might seem like pie in the sky now, you’ll wake up and the divorce will be behind you, and that leaves you with the opportunity to create a brand new life. It may not be a blank slate logistically, but it’s certainly a very different life than the one you were living before. Your tomorrow self will thank you for taking the right steps and setting yourself up to win now.
Some things to think about:
- The splitting of financial assets is largely guided by the laws of your state. It’s okay to take your half. I’ve spoken with many clients who regret letting their spouse “have everything” (or close to it) out of guilt or regret.
- If you haven’t been working or haven’t been earning enough money to pay your overhead, now is the time to learn a technical skill that can earn you a high wage. Financial struggles are stressful! Give yourself the gift of abundance.
- While “retail therapy” is a real thing, don’t let it get out of hand. Splitting households means giving up many of the efficiencies of living together. You’re going to need to be certain that you can support yourself on your own so keep expenses very low until you’re confident you’re back on financial track.
Setting financial goals based on your newly independent status can make the outcome of a divorce settlement that much more satisfying if you know you’ll be set up for success as best as possible under the circumstances.
Not Splitting Your IRAs Properly
Retirement accounts make up 34% of the financial assets that get decided on during a divorce settlement. That means that retirement accounts will be part of a divorce settlement and decisions will be made on how to split these assets fairly between parties. However, IRA accounts, in particular, have steep tax and transfer penalty consequences if they aren’t handled properly. Therefore, make sure the transfer of funds is done correctly to avoid any unnecessary losses.
- Make sure funds are transferred via what is known as a divorce decree or legal separation agreement.
- Avoid transferring IRA funds via a private separation agreement. Under a private separation agreement, the spouse giving up the assets would be subject to the early distribution penalty of 10%, and the receiving spouse would not be allowed to accept the funds in an IRA as a nonreportable transfer.
- Make instructions to the IRA custodian clear. Meaning, you should provide the IRA custodian with a copy of the divorce decree that plainly states how assets should be transferred from one specific account to another and the dollar amount of assets being transferred.
- Follow instructions and make sure you provide the necessary signatures. Whenever you instruct an IRA custodian to split assets, you have to ensure you follow their instructions to the letter so that there are no errors or delays. This often includes both you and your spouse signing documents confirming transfer amounts and account numbers.
Accepting the House as Part of the Settlement Before Running the Numbers
A home has a lot of sentimental and monetary value and can be the one asset that is hardest for splitting spouses to decide how to handle or who gets it. Keep in mind, a home comes with an outstanding mortgage payment (most likely), as well as all the ongoing costs to maintain the home like taxes, insurances, and anything that requires fixing.
Before you fight and claw over who gets the house, run the numbers first to see if you can afford it without your spouse’s income. Get an independent estimate of the home’s current fair market value. As best as you can, treat the house objectively as a financial asset, and if it doesn’t enhance your financial well-being after the divorce and will negatively impact your finances, consider giving it up altogether.
Depending on Alimony
From a financial standpoint, basing your financial future on alimony may undermine your own income earning potential and long-term financial success. After all, alimony and child support are not guaranteed, so make sure you have a plan in place for when it ends or if it ends sooner than expected.
If your ex-spouse owes you alimony or child support, one piece of the divorce agreement should be that you own a term life insurance policy on him or her. You would pay the premiums (to ensure that they do get paid), and it’s possible to have those premiums be part of the divorce agreement itself so that you would get credit for them.
Starting the process of living financially independent as soon as possible following a divorce helps you make smarter financial decisions now. Waiting until the support stops and then being hit with the reality of an unfunded or insecure financial situation can have devastating consequences if you aren’t prepared to support yourself fully.
One of the best things you can do if you or someone you know is preparing for a divorce is to start building a team of financial advocates now. In my financial planning practice, I often partner with my clients and their divorce attorney through the divorce negotiations. I help my clients get financially organized, sort through all the financial details, understand where they stand financially, and envision the life that is possible after divorce. Then, their legal team is that much more prepared to negotiate terms that protect and preserve my clients' financial well-being.
With proper direction and advice, the end of a marriage becomes a new beginning and one that can and should start on the best financial path possible.