DISSOLVING THE MARITAL CONTRACT

Overview

When a marriage ends in divorce, it can take a long time for one or both spouses to recover their emotional stability — but they generally do. About 40 percent of today’s marriages involve one partner who has been married before.1 However, the financial impact of a divorce can last for quite a long time — even a lifetime. In fact, the financial pressures of going it alone without a satisfactory safety net may be an underlying reason why many people decide to remarry.

For the sake of healthy relationships in the future — for ex-spouses, their children and even potential future spouses — it’s very important to resolve financial issues during a divorce to help secure the financial future of both parties. This is especially true when children are involved, because they shouldn’t have to see one parent suffer financial consequences.

It’s a good idea to work with a financial advisor from the outset of a marriage to put plans in place to help a couple build significant net worth during the span of their union. However, there is perhaps no better time to involve a financial advisor than during a divorce. After all, divorce attorneys are not trained to provide comprehensive financial planning advice.

Divorce, unfortunately, is seldom quick or neat. In terms of money, it can be expensive and leave spouses in dire financial straits. Therefore, it is a critical time for all assets to be identified and divided between spouses appropriately and efficiently in order to meet short- and long-term goals for both parties. Indeed, this is no small feat.

Property Division

Division of property in a divorce depends largely on where the couple lives. In a common law property state, an asset that is acquired and titled by one member of a married couple is owned exclusively by that person. If a title or deed for property lists the names of both spouses, that property belongs to both spouses — with each owning a one-half interest.

In the event of a divorce, the couple can enter an agreement on how to divide assets. However, if the case goes to trial, the court will decide how marital property is divided. By contrast, there are nine community property states in the U.S.:

  • Arizona
  • California
  • Idaho
  • Louisiana
  • Nevada
  • New Mexico
  • Texas
  • Washington
  • Wisconsin

In a community property state, all assets acquired during the marriage are considered owned equally (50/50) by both spouses, regardless of how they are titled. This includes all debts, earnings and property purchased with income or earnings accumulated during the marriage. However, assets acquired before the marriage and any property given to or inherited by only one spouse before or during the marriage are considered to be separate and owned exclusively by that spouse.

In a divorce, the separate property of each spouse is distributed to the spouse who owns it, and the rest is divided evenly (50/50). If an asset, such as a house, is granted to one spouse, the other spouse will receive assets equal to its total economic value.

Potential Problems

Let’s say the ex-wife is granted majority custody of the children and also full ownership of the family home. The ex-husband then receives an investment portfolio equal to the home’s value. While this may appear equitable on its face, consider that the house will require insurance payments, upkeep and maintenance costs, and perhaps even a significant tax burden when it is sold. The costs associated with the investment portfolio may not be nearly as onerous.

Sometimes, it may make sense to consult with a financial advisor before even broaching the idea of splitting up a marriage. Understanding state laws and the potential impact of dividing assets can help a couple determine whether they can even “afford” a divorce.

QDRO: Qualified Asset Division

For older couples, assets accumulated in retirement accounts and/or pension plans may account for a large part of their net worth. Be aware that federal law states that assets earned through participation in an employer-sponsored retirement plan can be divided between ex-spouses only by a qualified domestic relations order (QDRO).

A QDRO must be submitted to and accepted by the plan sponsor before a divorce is finalized. Note that a QDRO applies only to a retirement plan sponsored by a private employer. Other types of retirement plans may require a different form that performs the same function. For example, retirement plans for federal government employees require a “Court Order Acceptable for Processing (COAP).

Be cautioned that if the appropriate form is not on file by the time the divorce is finalized, a former spouse may have no rights to the participant’s retirement benefits — a fact that often does not come to light until years later when the ex-spouse retires.

IRA

IRA accounts are divided according to state law and agreements pertaining to divorce proceedings. However, it is important to understand that when IRA assets are to be split into separate accounts, the IRA custodian must be notified that a transfer or rollover is part of a divorce decree in order to avoid taxes and/or an early withdrawal penalty. This is another reason to work with a financial advisor to help ensure assets are transferred correctly.

“In the modern era, a good divorce is better than a bad marriage.”

New Financial Planning

Remarkably, there can be a silver lining to divorce. Each spouse has the opportunity to develop a financial plan specific to his or her new lifestyle and goals. If money was a constant issue during the marriage, as it often is, a single person generally has control of his or her income, saving, spending and investment decisions from the divorce on. This fresh start also presents an ideal time to work with a financial advisor to identify goals, savings and investment vehicles, an allocation strategy, risk profile and timeline to meet those goals.

Bear in mind these tips when developing a new solo financial plan:

  • Update beneficiaries for personal investments, bank accounts and qualified retirement plans.
  • Update the beneficiaries for all other financial assets, such as annuities and life insurance.
  • Develop a new estate plan that includes choosing a person to be your health care proxy, asset beneficiaries and, if necessary, a guardian for your children.

As troublesome as divorce can be, there is always a tomorrow and a new opportunity to secure a brighter financial future.

Final Thoughts

As a couple enters divorce proceedings, it’s important to consult with an experienced financial advisor to help navigate issues related to dividing assets and ongoing alimony and/or child support payments.

As a final thought, when engaged in a contentious separation in which both spouses have their own divorce lawyers, they should perhaps consider having their own professional financial advisors, too. While an attorney may understand legal issues, a financial advisor is better prepared to analyze and understand the performance potential, tax implications and long-term outcomes of financial assets and — perhaps most important — represent the individual client’s best interests.