By: Lloyd D Lowe Sr, Founder & CEO – LD Lowe Wealth Advisory
When couples say the words “I do,” it’s unlikely they envision a day that the words will become “I don’t.” When that day comes, it’s important to have strong, knowledgeable advocates who can help smooth the transition and ease both the emotional and financial impacts of this significant life change.
Financial planners are in a unique position to assist clients who are seeking a divorce. Divorce can be a tense and complicated process, but if a client engages a financial planner early in the process, keeping a level head and planning in advance can help avoid costly fees and arrive at an equitable division of assets and liabilities.
Equity is an important consideration in divorce, and it is crucial to consider equity within a larger scope than simply what is listed on paper.
For example, consider a wife who has been a stay-at-home mom for many years who has re-entered the workforce. While she may have a steady, respectable income that will meet her current needs, she is likely making less than she would have had she been working during that period. Add to that, she has not had the opportunity to save separately for her own retirement from her wages and her personal wealth is less than that of her husband, who has benefitted from compounding interest over the same period. This can create a significant inequity when looking at both her current and long-term financial plan, and it should be accounted for when dividing joint assets and when considering alimony.
Another example may be a woman-owned business where the husband is a minority shareholder. In order to maintain minority-, woman-owned business enterprise (MWBE) status, it may make sense for the business to continue under the wife’s leadership post-divorce, but the husband’s interest must be bought out at a rate that may be higher than his percentage ownership in the business when considering a familial division of equity. Depending on the assets available to the business, the division may include payments over time, or compensation from other joint assets during the division process.
If the couple has children, child custody and child support payments are key considerations. In this case, it is best to work with a family law attorney who can help navigate important laws and determine the correct, ongoing support, which may include monetary payments and health insurance coverage, as well as visitation rights.
There are many financial areas to explore when determining an equitable split, and the most common are assets, debt, taxes and estate planning.
Divorce and Assets
In a divorce, the common place to start is deciding on the equitable division of assets. Joint assets of a marriage may include: house; other real estate; stocks, bonds and securities; bank accounts; individual retirement accounts (IRAs); automobiles, boats or other such tangible assets; and collections, artwork and antiques. In some cases, family trusts or family businesses may come into play.
The family home is usually a key consideration. Often, the simple solution is to sell the home and divide the proceeds among parties. However, one party may wish to keep the home in order to maintain continuity for the children, for example. In this case, it is important to understand whether a refinance of the loan is warranted. For other assets such as cars or boats, each person should determine those he or she wants to keep and which to assign to the spouse.
Regarding a family business, it will be important to know whether the state values assets at the time of separation, settlement, divorce or another time. For collections, artwork or antiques, compensation to the spouse not receiving those assets is warranted, and a value must be determined.
Divorce and Debt
In general, both spouses are responsible for debts incurred during the marriage, regardless of who actually spent the money. Usually when splitting the assets, the party who receives the asset also has the responsibility for paying an indebtedness secured by it. There are three types of debt to consider: secured debt, unsecured debt and divorce expense debt.
- For secured debt, the terms of the separation agreement can make it very clear which party will be responsible for payments so the creditor may not pursue the other spouse in the event of default.
- Unsecured debt is an area where financial planners need to exercise great care. For one, debt can still be incurred during the separation period prior to a final divorce. In that case, a judge will likely assign that debt to the party who incurred it. However, the balance of the account going into separation is often treated as a joint responsibility. As an example, if one spouse incurs $30,000 in debt on a personal credit card, the other spouse would be responsible for $15,000. If the primary cardholder fails to pay the balance post-divorce, the credit card issuer could legally pursue the other spouse for the entire $30,000 balance. Therefore, it is important to work to separate such debt, assign it to a single party, and alter the contract with the creditor accordingly.
- For divorce expense debt, a consideration should be made whereby the higher-earning spouse assists the lower-earning or non-working spouse with attorney and court fees during the proceedings to ensure proper representation for both parties. These arrangements can be made formally through the courts at the outset of the divorce process.
Divorce and Taxes
A couple’s tax filing status is important because it determines, in part, the deductions and credits available to each spouse, the amount of standard deduction that he or she may be entitled to, and the correct amount of tax. The five possible filing statuses include: unmarried, married filing jointly, married filing separately, head of household, or qualifying widow(er) with dependent child.
For tax purposes, whether the couple is considered married or unmarried isn’t as obvious as it may seem. It depends on a number of rules and his or her legal status as of the last day of the tax year. In order to minimize income tax liability when contemplating divorce, it may be possible for the couple to plan the timing of any changes in filing status.
If the couple files a joint tax return, each will be liable for tax debt in the year the divorce occurred. In addition, for several years after the filing, both parties may be subject to an audit by the Internal Revenue Service (IRS). To avoid potential future tax problems, the divorce agreement should make clear what happens if any additional interest, penalties or taxes are imposed for a prior tax year. It is also important to know “innocent spouse” rules may offer certain protections to a taxpayer whose spouse understated the tax on a joint return. In addition, escrow arrangements are sometimes employed in divorce situations to ensure sufficient funds will be available to pay for contingencies.
Divorce and Estate Planning
Wills for both spouses are usually drawn up during the marriage, particularly if children are involved, and often there are trusts established for children at that time. When a divorce occurs, beneficiaries and executors need to be revised, and gift and estate tax aspects of the estate plan should be examined. It is also possible that one party to the divorce could die during the separation period. For this reason, it is important that divorcing couples consider revising their estate plans during the separation period and not wait until the divorce agreement is finalized.
A formal separation agreement should establish the spouses’ rights regarding property, debts, temporary alimony, child support and child custody. When heirs are involved, it will be important to assign their rights as well. First, make changes to ensure the spouse isn’t named as the other spouse’s personal representative, successor trustee, beneficiary or holder of power of attorney. This generally involves drafting a new will. Note that in some states, wills drawn up during a marriage are considered void after a divorce unless specifically ratified after the divorce. This means that intestacy rules would apply, instead of the will being controlling.
Next, consider gift tax implications to fund a child’s education as part of the property settlement. While tuition payments are exempt from gift tax when required by a property settlement agreement, be aware that payments for educational expenses such as books and room and board may be subject to gift tax.
Finally, the absence of the unlimited marital deduction should be considered. Because this gift and estate tax deduction is one of the most important estate planning tools for married couples, a spouse’s loss of this tool due to a divorce can affect the tax situation of his or her legacy.
Because many of the issues involved with divorce may require the help of outside experts, such as family law attorneys and family counselors, financial planners who want to focus on divorce planning would do well to develop relationships with trusted partners to whom they may refer clients for advice.
Our firm continually works to align with top-rated professionals in their fields who will treat our clients with the same respect and offer the same level of service we provide.
Divorce can be a lengthy process that may leave you feeling emotionally drained, financially uncertain and out of control. But with help from trusted partners to develop the right plan of action, you can take charge of the situation, protect your interests and save both time and money.