Divorce and Finances: 6 Common Financial Issues to Keep in Mind During this Transition
Divorce can be extremely stressful, and often dealing with the finances may seem crippling. Although the primary focus is on your family and mental health, your financial situation needs to be top of mind as well. Keeping divorce and finances in mind will prepare you for this next chapter and avoid mistakes that may impact your future. Here are 6 of the most common financial issues to address if you are considering a divorce or are working through these logistics already.
Changing bank accounts and titling
Don't do this too early in this process! But, as soon as the divorce decree is in place, you can start to retitle and position your assets for what is best moving forward. You will want to make sure any joint accounts are now in your name only and that you have adjusted ownership rights.
How to handle retirement accounts, your 401k and divorce
For many, a majority of your assets may be in retirement vehicles. When determining how assets may be split, retirement accounts also come into play. You may find 401(k)s are divided through something called a Qualified Domestic Relations Order (QDRO). A QDRO is an order splitting retirement plans, allowing a portion of an individual's retirement account to be moved into an ex-spouse's account under similar tax guidelines. We often also see pensions as part of an agreement if both parties are unable to find common ground on more liquid assets.
What to know about real estate and divorce property settlements
Typically a family may own one home or disagree on which properties belong to which spouse, if multiple properties are owned. With properties, the individual who would like to keep the house may need to refinance and pay cash for a portion of the property's value to make the other party whole. For the individual who holds the property, any debts are typically carried over to this person leaving all payments and burden on the individual who kept the property.
For example, I have a client I started working with after she went through a divorce. She had a very strong emotional attachment to their home; she was adamant about keeping their property and gave up a lot of liquid assets to ensure this was the case. The challenge was that when the time came, she had to sell a significant portion of her assets to buy this property from her ex-spouse, thus leading to serious tax and planning impacts. Although owning this property was important to her, it is critical to understand the full scope of your decisions throughout the divorce process to ensure you are prepared to handle the fallout.
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Keep these considerations in mind around child support and alimony
If you have younger children, more often than not, some degree of child support or alimony may be agreed upon. Depending on which type of payment is specified will dictate who pays taxes and to what degree. Child support payments are not taxable to the spouse receiving the funds, but alimony payments are. Although alimony is taxable to the recipient, the spouse who is paying these benefits will be able to deduct any alimony payments from their income.
I helped a client recently who was going through a divorce and was conflicted on how best to set up payments from one spouse to the other. Since one spouse was not working and going to be in a significantly lower tax bracket, we put together a strategy based on alimony payments instead of child support. The strategy allowed the higher-earning individual to deduct these alimony payments off their income and reposition these dollars to the lower-taxed party in the divorce. Because of the tax implications of alimony payments, the higher-earning individual was actually able to provide a larger payment to the recipient. This larger payment was offset by the tax deduction, allowing the lower-earning party to receive a higher payment as well based on their lower tax bracket. Both parties were happy to do this because this allowed each person to keep more money based on their tax circumstances and created a win-win scenario. These types of strategies are rarely addressed comprehensively but can make a huge difference for everyone involved.
Taxes and your finances after divorce
After a divorce, one typically moves from filing taxes as married filing jointly to filing as an individual or head of household. Especially when there is a higher income earner of the two spouses, at divorce, the tax impacts to the higher earner can be significantly more as an individual tax filer. After the dust has settled with any splitting of assets, it is also imperative to understand the tax impacts of selling or taking distributions before making these decisions. The tax circumstances are often skewed to one side or another, so having some help identifying and preparing tax consequences is critical.
Be sure to update beneficiaries after divorce
Updating account beneficiaries is a big one! More times than you may even believe, I have started working with a new client only to find accounts with beneficiaries from three marriages ago! The challenge here is that beneficiaries are usually the first line of defense regarding asset distribution at your passing. Even if you have a will that states otherwise, the beneficiary designation will usually trump these legal documents. So, it is crucial to update your beneficiaries as soon as you feel appropriate after divorce. At this time, it would also be prudent to update estate planning documents (such as wills or trusts) to reflect these changes. Some typical beneficiary designations to update include 401(k)s, IRAs, old company retirement plans, insurance policies, and more.
Get some help with a divorce financial advisor and a family law attorney
Typically, one spouse may have been preparing for a divorce while the other is caught on their heels. Be sure to find some help before signing any documents in this process. The spouse that has prepared typically has a leg up, whereas the other has not had the time to consider all angles. Whichever position you are in, it is essential to get some help when it comes to divorce and finances. During this time, turn to a family law attorney and financial planner who understands your situation, whom you trust to navigate these choices, and provide an objective approach.
If you are considering or going through a divorce, understanding the impacts of divorce on your finances is extremely important for your long-term well-being. It may be wise to turn to professional, unbiased help during this difficult time. These six common concerns around divorce and finances will provide a great starting point in those conversations, and if I can be of any help, please reach out to me anytime.