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Financial Planning for Divorce

At best, divorce is a time of distraction in one’s life, when emotional and family concerns take center stage and financial issues often take a back seat. Yet divorce is one of the biggest triggers of bankruptcy in a world where bankruptcy has gotten a lot tougher to file. That means that financial planning is crucial when a marriage breaks up. The best time to do that planning is before the divorce is final, not after.

Anyone filing for divorce should seek the help of financial and tax advisers as well as attorneys skilled in divorce, experts say, because the financial issues that get pushed to the background eventually can take a surprising and disastrous toll on the newly single ex-spouse and his or her children.

As the following chart shows, divorce rates have plenty to do with money, race, and age, according to data from the National Survey of Family Growth from the Department of Health and Human Services. Whether a breakup is friendly or contentious, your approach to divorce has to be strategic. This is often a tough adjustment for spouses who had previously lived a philosophy of supporting the other’s decision-making at all times. In the friendliest cases, divorce is a collaborative event, but more often, it is not. It requires firmness and good advice from tax, legal, and financial experts, including professionals.

Chart showing probability that first marriage breaks up within 10 years by race/ethnicity and median family income in the community.

Don’t forget that divorce is a major cause of bankruptcy. Divorced people who file for bankruptcy genuinely failed to plan for all of their expenses and living costs before they made their final settlement.

Understanding the Financial Trauma of Divorce

Women typically suffer the most serious financial consequences from divorce. They often earn less than their husbands, and they usually are the ones taking care of any children. Even if the husband provides full child support, often it is not enough.

Men, however, do not always escape the financial quicksand of divorce. Divorce creates two sets of expenses: two housing costs, two food bills, two utility bills, two phone bills. New expenses such as child support, child care, and new furniture and appliances add to the financial burden. Together, a dual-earning couple may have maintained a good standard of living. Apart, neither party may fare well.

Adding to the woes, one party may break promises in the divorce agreement, such as failing to help pay debts created jointly during marriage, or worse, running up credit card debts both parties are liable for. Tax consequences further complicate the process. New rules, designed to make divorce more financially equitable, also have made it more challenging. Today, in most states, assets acquired during marriage are tossed into a common pot and then divided equally. Negotiation is fast, replacing litigation under this system, but it also means accountants, tax specialists, and property appraisers may need to be brought in.

Prenuptial agreements can minimize or avoid later financial conflicts. An inventory of assets every few years and establishment of each partner’s contributions to those assets also can help smooth matters. In the event of a divorce, the couple should consider bringing in a financial planning professional, in addition to hiring an attorney and other professional experts. The planner can help in two ways. First, they can help put together an equitable settlement by determining family assets and fair value, as well as current liabilities. Second, they can help estimate and plan for each partner’s post-divorce income, tax consequences, cash flow, and retirement picture, which still need to be planned for.

Start With a Budget

No matter how sophisticated you think you are about your finances, don’t pass up the opportunity to do a basic financial budget for your new life as the divorce process begins. A professional can help you ask the basic questions that will help you understand what life will be like when you are living with a single job income stream or a temporary income stream provided by an ex-spouse. Find an attorney or other adviser who is friendly toward the mediation solution first, then ask for suggestions on qualified mediators.

Properly Value Your Assets

If you’re getting the house, does it have a 20-year-old furnace and a roof that’s about to cave in? A thorough inspection by a licensed inspector could help. If you’re getting the family car, is it past warranty with a funny sound coming from under the hood? If your spouse runs a lucrative business that you’ve worked for or invested in, how do you know you’re getting the right share? Hiring a valuation expert may be necessary.

Financial Myths of Divorce

Even though so many Americans divorce, most are misinformed aboul how breakups affect their money issues. Here are some myths that many inexperienced couples face before they file:

Everything is automatically split 50/50. The standard in most, though not all states today, is “equitable distribution.” What that means, however, varies from state to state and even judge to judge. Equitable does not mean “equal.” Rather, how the couple’s assets are divided up depends on numerous factors, including the length of the marriage, income of each party, age and health of each party, education, earning capacity, and so on. Assets each party brought to the marriage, or received separate from the marriage, such as gifts and inheritances, may or may not be included as part of the marital property.

All assets are equal. It’s not as simple as “he gets the pension, she gets the house.” When taxes. sales expenses. investment returns, and other factors are taken into account, all assets are not equal. A $100,000 home and $100,000 in a pension fund will not likely have the same value years from now, and the tax basis of each asset also could adversely affect the net value.

Divorced women are better off financially than they once were. According lo one widely quoted study, women and children suffer an average 73 percent decline in their standard of living within one year, while men increase their standard by 42 percent. Typically, this is because women don’t earn, on average, as much money as men, have more limited work experiences. are raising children, and so on.

Only divorce lawyers can work out the financial settlement. Many attorneys are not well-qualified lo determine the most equitable financial arrangements for each party. Increasingly, divorcing parties are bringing in financial specialists such as financial planners, either in the mediation process or in a judicial setting, to examine the financial data and work out a financial settlement that takes into account present and future taxes, cash flow. inflation, investment returns, needs, and other factors. They project what the settlement will mean financially, not just now but years down the road. For example, who will pay for the children’s college education years from now, and how? Or what effects will inflation have on the assets or alimony payments? The wife should get the house. This may sound like a good deal for the wife, especially if she has custody of any children.

My spouse will support me. My spouse will provide child support. According to a 2001 U.S. Census Bureau study, approximately 6.9 million of the 7.9 million custodial parents with child support agreements or awards in 2002 were due payments from those awards. Among these parents who were due support in 2001, 73.9 percent received at least some payments directly from the noncustodial parent. a proportion unchanged since 1993. The average annual amount of child support received for these parents receiving at least some support was $4,300, and did not differ between mothers and fathers.

Planning Properly for Kids’ Welfare

In many states, college-age children have the right to demand financial support or college funding at the state level so their education isn’t interrupted. While both parents should advocate in their kids’ best interest, this isn’t always the case. Be aware of your state’s divorce laws with respect to secondary child support.

Get help documenting child support. Child support guidelines vary from state to state, but are generally set in the state where you and your children live, so become aware of those provisions. Also, if your state has a special program that allows a spouse to pay into a special account so child support is recorded every month, consider it. It’s a good idea to enroll because it provides a paper trail and enforcement system for ensuring that kids get the money they need. Federal law requires all child support payments be made by wage assignment and health insurance by health insurance orders. Child support collection statistics reflect that only 20 percent of noncustodial parents pay their court-ordered child support monthly. That’s why so many laws have been established to force compliance. Make sure you know them.

Protect Yourself From A Tax Standpoint

There are always special situations in a divorce that will determine whether a couple will need to file jointly or separately during the last year that the marriage exists. This is definitely worth discussion, since tax fraud can be a liability issue for the spouse who had no involvement or awareness of the fraud taking place.

There are many other tax issues. Regarding children, custodial parents who are responsible for the child’s care more than half the year are entitled to head-of-household status that would ultimately lower their tax bills. However, the other spouse should also check to see whether they have tax advantages in this situation. Tax treatment of alimony, capital gains (from the sale of the family home), child support, pension division, and other issues need to be discussed with a tax professional.

Don’t Overlook Insurance

Amid the emotional trauma of a divorce, and the battles over who gets the kids and what property, one important financial aspect of the breakup is often overlooked: insurance. The failure to incorporate insurance needs-health, life, disability, homeowner’s, and so on-into the divorce process can have severe financial repercussions.

Health insurance. If you were covered through your spouse’s plan, either at work or through an individual policy, you’ll likely need to find new coverage. As part of the divorce settlement, you may be able to require your ex to continue coverage on you, but it’s not likely. That leaves you with three choices.

Your first and probably best choice will be to get coverage through your own employer. If you don’t have coverage through work, you probably will be able to continue coverage through your former spouse’s plan for up to 36 months under the federal law COBRA. But you’ll have to pay the full premiums and a small administrative fee. Another option is to buy an individual policy.

What about the children? Even if they live with you, they can qualify for coverage under your former spouse’s plan until they are adults. You can make this happen through a qualified medical child support order (QMCSO), a court order that provides health benefit coverage for the child of the noncustodial parent under that parent’s group health plan. You may run into limits, however, if your spouse’s plan is an HMO (health maintenance organization) and you move with your children out of the IJMO’s region. Then you may be restricted to emergency coverage only. Make sure you discuss all the possible causes of interruption of that coverage if you plan for your ex-spouse to cover your kids.

Life insurance. Spouses who will be paying maintenance or child support should carry adequate life insurance on themselves in order to secure court-ordered obligations. The key here is for the other spouse to make sure the insured doesn’t change beneficiaries or simply drop the policy without notice (including those at the workplace). One strategy is to ask the insurance company to send a duplicate notice of cancellation or beneficiary changes. The court also may order periodic proof from the insured that proper coverage is being maintained or that if the spouse drops the coverage, there will be penalties or an equivalent amount taken out of the deceased’s estate. (This assumes there is enough in the estate to make up for the lost insurance benefits.) It is very important that your attorney advises you on how to structure this life insurance issue in your settlement so there are no tax headaches later. You also will likely want to drop your ex-spouse as beneficiary of your own life policies, unless, of course, you’re the one paying maintenance.

Even if you’re receiving maintenance or child support, you may want to list your ex-spouse as beneficiary if he or she has to take on the financial obligation of raising the children should you die. Once’ you remarry, of course, you’ll likely want to make your new spouse your beneficiary. On the other hand, if you don’t have children and no one else depends on you financially, you may want to drop life insurance coverage now that you’re on your own.

Disability insurance. Many divorce experts recommend that the person providing maintenance or child support payments have adequate disability coverage in order to continue payments in the event of a temporary or permanent disability. And the person taking care of the children also should have coverage, assuming he or she works. Review the policy to see whether you need to beef up the amount.

Homeowner’s insurance. If you are not a “named insured” on your homeowner’s policy, your personal possessions won’t be covered once you divorce. And if you move out of the house before the divorce, generally, insurers will limit coverage of your personal possessions to only 10 percent of their covered value, even if you are a named insured. Because there may be many complex insurance issues to review, consider consulting with your financial planner, who also may be able to help you with other financial issues of the divorce settlement.

Once the Divorce is Over – Watch the Spending

It’s a wise idea for newly divorced individuals to work with a financial adviser to set up their initial budget. But it may be equally important for the person to set up a review visit at the one-year point after the divorce to get a fresh perspective on how their new single lifestyle has affected their finances.

Financial Planning for Divorce by