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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?
“Separation or divorce is a time when both of
you should reduce your spending...”
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.
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 (formerly known as the Institute for Certified Divorce Planners). For more
information about how a CDFA can help you with the financial aspects of your divorce, call
(800) 875-1760 or visit their website at www.Institutedfa.com.
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