Few divorces approach the recent $36 billion settlement between Amazon founder Jeff Bezos and his wife, MacKenzie. But divorce can have a big financial impact no matter what your assets look like.
Here’s what you need to do to avoid being surprised—and hurt financially more than you have to be—if you contemplate divorce…
Take into account future taxes when splitting up assets. Say one spouse opts for a 401(k) or an IRA worth $250,000 in the divorce…while the other takes the house or a nonretirement account worth $250,000. That might sound fair, but the spouse who gets the retirement-plan assets may be getting a bad deal if it’s a traditional 401(k) or IRA—he/she likely will end up having to pay taxes on distributions. (This generally doesn’t apply to Roth 401(k)s and Roth IRAs if the account has been held at least five years and the account holder is at least 59½.) If this spouse hasn’t reached age 59½, the spouse also might face a 10% IRS penalty on a portion of the assets if he takes an early withdrawal.
What to do: Before accepting a divorce proposal that involves keeping most or all of a traditional 401(k)/IRA, confirm with your divorce attorney that the settlement takes the potential future tax bite into account.
Beware spending lots of money to search for hidden assets. Some spouses attempt to conceal assets before their marriages end so that they don’t have to split them with their soon-to-be exes. Money might be withdrawn from a bank account and hidden away…valuables might disappear from the home…or the spouse might say he has had big gambling losses. Unfortunately, hiring a forensic accountant to track down missing assets and/or engaging in a protracted legal battle over them could easily cost tens of thousands of dollars or more, with no guarantee of success. Unless the soon-to-be-ex is believed to have hidden a small fortune, tracking down these assets likely will cost more than it recovers.
What to do: Rather than launch a big investigation into hidden assets, people going through divorces should express their concerns to their attorneys and provide any evidence—for example, account statements showing mysterious withdrawals…or insurance inventories listing valuables that no longer are in their usual spots in your home. Also provide the attorney with copies of recent joint tax returns, which sometimes provide clues about hidden assets. The attorney could ask the suspected spouse pointed questions about these issues during a deposition or interrogatory. Spouses who have hidden assets often admit to what they have done when confronted directly because they fear getting caught lying under oath.
Decide whether or not it makes sense to hang on to the home. Keeping the home is a common goal for divorced people, but family homes often are unnecessarily large for single people or single-parent families with children who will soon strike out on their own. And owning the home can tie up a huge chunk of a divorced person’s remaining wealth. Home maintenance can be difficult for a single person or expensive if outsiders must be hired to help with chores and repairs previously handled by the former spouse. And if there’s a mortgage on the home, it likely will have to be refinanced in only the remaining homeowner’s name—which might not be possible if this spouse doesn’t have sufficient income to qualify for the loan…or the new loan might come with a higher interest rate.
What to do: Set aside any emotional connection to the home, and think objectively about whether keeping it is the best use of assets after divorce. Estimate how much the mortgage, taxes, insurance and home upkeep will cost, then see how all this fits into a realistic post-divorce budget. Speak with a mortgage lender before finalizing divorce terms to see if it even will be possible to qualify for a new loan as a single homeowner—and if so, at what rate.
Don’t assume your ex will do what your divorce agreement says he will do.
Divorce might not mark the end of fighting about money with a spouse. Some former spouses don’t make required alimony or child-support payments. Also, an ex might fail to pay the premiums on a life insurance policy that names his former spouse as beneficiary even if it is required by the agreement.
What to do: If payments from an ex are a crucial component of your post-divorce income, create an emergency fund—or some other contingency plan, such as getting a home-equity line of credit (HELOC)—in case payments are missed. It could take many months to resolve the dispute through the courts. If any special payments are required down the road, create a calendar that lists these or arrange e-mail reminders from a calendar program such as Calender.Google.com to ensure that they are not missed. If you are the beneficiary of a life insurance policy under the divorce agreement, make sure the agreement requires your ex-spouse to regularly provide proof that the premiums are being paid and the policy remains in effect.
Separate any joint financial obligations. Perhaps the divorce agreement assigns the ex-husband the responsibility for paying off the credit card that he usually used…and the ex-wife responsibility for paying off the one she usually used. That may seem like a fair agreement—until debt collectors start calling both former spouses because one hasn’t made his/her payments.
Lenders are not obliged to honor the terms of a divorce. If a loan or credit card account was opened in both ex-spouses’ names—or you live in a community-property state—the lender will consider both people responsible for payments no matter what the settlement says. The ex who wasn’t supposed to be responsible for the debt could sue his former spouse for not living up to the terms of the divorce agreement, but that could take months to sort out and cost thousands of dollars in legal bills.
What to do: Seek a divorce agreement that requires as much debt as possible to be paid off before the divorce is finalized. Debts that cannot be paid off should be transferred to new loans/accounts that are opened in just one spouse’s name, and the joint loans/accounts should be closed. If one spouse is keeping the house, the mortgage could be refinanced with a loan taken out in only that spouse’s name, with the other spouse agreeing to transfer the title to that spouse.
If the spouses are not able to pay off all joint debts before the divorce, the ex who is not responsible for paying off a debt should insist on receiving account statements proving that debt payments are being made as directed by the divorce agreement.
Be aware of the possible ways that alimony could end. It’s common for divorce agreements to include clauses terminating alimony if the ex on the receiving end remarries or even if she cohabitates for a specified period of time. Also, an ex who pays alimony might return to court to ask that the payments be reduced if his income declines…or if the recipient’s income increases. And alimony payments end if the payer dies. The surviving ex can make a claim on the estate for any payments owed at the time of death, but unless there are life insurance proceeds for unpaid alimony, no further payments are required.
What to do: Spouses who will receive alimony should review the terms of their divorce agreement before moving in with a new partner to make sure that they understand the potential financial implications. And they should resist the urge to brag about salary increases to their former spouses.
Also, a divorced person who will depend on alimony should confirm with his/her attorney that the divorce agreement will include a life insurance policy on the other former spouse’s life, naming the alimony-dependent spouse as beneficiary.
One more alimony twist to keep in mind when constructing a post-divorce budget: Under new tax rules that affect divorces finalized in or after 2019, former spouses who pay alimony no longer can deduct those payments from their income taxes…and spouses who receive alimony no longer have to pay taxes on this money. (These new rules do not affect you if your divorce was finalized prior to 2019.)
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