Aug 12, 2016

Divorce and Finances: 6 Mistakes to Avoid

If you are struggling with divorce and finances, you are definitely not alone. Almost a million marriages end in divorce in the U.S. each year. That’s almost a million couples hashing out their finances, dividing their assets and going their separate ways. Divorce takes a toll on all parts of a person’s life. It’s an emotionally turbulent time and decision fatigue almost always sets in at some point in the process. The financial decisions you make, or pass on, can have lasting and costly consequences. Avoid these six major divorce and finances mistakes to start the next chapter of your life in solid financial shape.

Mistake #1: Not adjusting your spending

Too often, people who undergo a divorce continue to spend as if nothing has changed. However, the financial needs of a divorced woman are significantly different than those of a married couple, and two separate households means more expenses for everyone, especially if there are children involved.

Start taking charge of your divorce and finances by creating a budget. It’s often easier to know where the money is coming from than where it’s going. Writing down all of your expenses allows you to see not only where you are spending, but where you can reduce or cut out expenses all together. Don’t forget to take into account your new tax situation and often-overlooked items like medical insurance.

Once you have a handle on where the money is going, figure out how to save 10% of your income if you aren’t doing so already. Saving is vital to a healthy financial future, particularly for women, who typically live longer than men.

Mistake #2: Thinking All Assets Are Alike

Not all assets are created equal. Some, like stock shares or mutual funds are highly liquid, and others, like antiques or a home, are illiquid. Liquidity refers to the ability or ease with which an asset can be turned quickly into cash. The liquidity of different assets that you and your soon-to-be-former spouse are divvying up can have lasting implications for you and your finances. For example, let’s look at the difference between a $30,000 car and $30,000 in cash. The car is an illiquid, depreciating asset that has additional costs and obligations associated with it (such as gas, insurance, registration fees, etc.). So, while both assets technically have the same value, you’d probably be better opting for the cash, as you will have more options for how to spend, save or invest the money.

The family home is the most common place where liquidity issues arise. Oftentimes, the spouse with primary custody of the kids wants to stay in the family home, but there are two potential problems to consider. First, there are the costs of maintenance and upkeep for a home. Trying to keep up with the costs of living in too much home for your new reality can seriously jeopardize your financial future. If keeping the house means you will be spending more than 30% of your income on your mortgage, that’s a red flag. You may want to rethink if staying in the family home is a prudent financial decision.

Second, holding on to illiquid assets, like the family home, often means giving up more in liquid assets to compensate. This can exacerbate cash flow issues, making the home even less affordable. It can also make the home a riskier investment, because there’s less of a financial cushion when faced with a financial emergency.

One final problem with keeping the house is the mortgage itself. As we’ll discuss later, you want to avoid joint liabilities in a divorce and refinancing the mortgage may not be possible using your post-divorce finances.

Mistake #3: Assuming the future will match the present

If you are the spouse who will depend on alimony or child support to make ends meet, it’s critical you protect that stream of income. Whether you acquire insurance yourself or make keeping appropriate life and disability insurance a condition of the divorce settlement, this often overlooked detail can have catastrophic effects. In addition, just having an insurance agreement as part of your settlement doesn’t mean you’ll actually be covered down the road.

A financial advisor can work with you to determine how much coverage you need and help make sure your ex isn’t underinsured. You should set up the policy so you are the owner and your ex is both the insured person and the one who pays the premiums. This way you won’t have to worry about the policy lapsing or the beneficiary changing (say to a new spouse!) without your knowledge. This in turn can help you avoid unnecessary stress and costly litigation down the road.

Mistake #4: Not Separating Your Finances ASAP

Once you are divorced or know you are headed in that direction, you want to make sure your former spouse can’t harm you financially. It’s not enough to rely on a divorce or separation agreement. Here’s a quick list of assets, accounts and documents to update:

Pay-off and close all joint credit cards
Pay-off any asset-backed loans or refinance them so they have a single owner
Close any joint banking and investment accounts
Update beneficiary information on retirement accounts and insurance policies
Update your will and any other estate planning documents

Mistake #5: Mishandling Retirement Accounts

If you will be receiving part of your spouse’s retirement plan savings in the divorce, make sure you don’t end up having to pay taxes or penalties on the distribution by getting a Qualified Domestic Relations Order (QDRO) put in place. This judicial order allows the retirement plan administrator to roll the money over to you without triggering unwanted taxes or penalties.

Another area often mishandled in a divorce is defined benefit plans (pensions). Even though the employee has to wait until retirement to receive payments, the pension has value today, and the non-employee spouse is entitled to a share of that value. In most cases, you’ll need to hire an actuary, a specially trained financial expert, to calculate the present value of the pension.

Mistake #6: Trying to Figure Everything Out on Your Own

The final and perhaps most important pitfall is trying to handle everything on your own. Many people require a lawyer to handle their divorce, but a lawyer is not a financial expert. So, while your lawyer’s focus will be on dividing your assets, custody agreements, etc., the right financial advisor will work with you to make sure you understand your financial situation and that you are on a path to meet your goals.

However, even if yours is a no-fault or uncontested divorce that may not require an attorney, it’s still a good idea to work with a licensed financial advisor to ensure you understand the financial implications of your divorce settlement and everything that’s at stake. Furthermore, in most marriages, one spouse is primarily responsible for the finances. This puts the other spouse at a tremendous disadvantage in terms of both information and expertise when the marriage ends. Even if you are the spouse who handled the finances throughout your marriage, there are many tricky details to consider when dividing assets and when deciding how to handle your finances moving forward.

The settlement you come to as well as the financial plans you create for yourself moving forward are perhaps the most important financial decisions you will make in your life. Working with an advisor who is experienced in this area and who is focused on your interests can help you achieve your financial goals and avoid any unnecessary missteps.

Check out these tips on selecting an advisor to get you started and request free proposals from licensed advisors when you are ready to find the right financial advisor for you.