A Guide to the Most Common Financial Issues of Divorce
A Look at the Division of Property, Debt, Retirement Funds, and Taxes in Divorce
Divorce is stressful emotionally, mentally, physically, and yes, financially. During a divorce, you and your spouse will be forced to make and accept decisions that have a major impact on your current and future financial situation and security. Don't go into them uneducated and alone. While many people choose to consult a family law attorney in their divorce proceedings, too few engage the expertise of a financial planner and/or CPA.
To understand some of the basics, here is a guide to some of the biggest financial concerns of a divorce. For more information on how to handle these financial concerns, be sure to check out How to Deal with the Financial Impacts of Divorce, which also includes discussion of child support and alimony.
Dividing Property in Divorce
Your marriage is coming to an end. Who gets the antique mirror your mother-in-law gave you last Christmas? Who gets the stocks in GE? What about the furniture? You car? How do you divvy up the accumulated belongings of years of marriage? Diving property can be as much decided by state law or court-order as it is compromise and agreement between you and your spouse. Currently, there is total of nine states in the United States (namely, AZ, CA, ID, LA, NE, NM, TX, WA, and WI) that are community property states. These states have laws that hold that all assets acquired during the marriage by either spouse are considered joint marital assets.
Joint marital assets are generally divided equally between the spouses in a divorce. Beyond the unique laws in community property states, there are several other routes taken for the division of marital property.
Surprisingly, many people come to a relatively amicable agreement about the division of property, but if there is disagreement about one or more items, there are a number of fair methods for deciding who gets what.
One of the most common is bartering, where one spouse takes certain items in exchange for others. For example, the wife may take the car and furniture in exchange for the husband getting the boat. Another method used in the division of property is to sell the marital property and divide the proceeds equally. Often times, mediators or arbitrators may also be used.
Be sure to familiarize yourself with the laws that govern the division of property in your state. You can find information for your state at DivorceNet.com. For detailed advice on how to save money in legal fees by dividing the property yourself, see Divorce Central's FAQs on Financial Issues of Divorce, which includes, among other things, an excellent discussion of the best way to deal with the family home in a divorce.
Dividing Debts in Divorce
Often even more difficult than dividing the property in a divorce is deciding who will be responsible for any debt the couple has incurred during their marriage. In order to do this, you'll need to know how much you owe. Even if you trust your spouse fully, do yourself a favor and order your joint credit report from each of the three credit reporting agencies. People have been known to run up debt without their spouse's knowledge, especially when they're contemplating leaving the marriage.
Overlooking this step could cost you years in debt repayments.
Next, go through the credit reports and identify which debt is shared and which is in your spouse's name only. At this point, it's important to stop the debt from growing any larger while you're in the process of getting divorced. The best way to do this is to cancel most of your credit cards, leaving perhaps one to use for emergencies.
Once you've identified your debts and taken steps to ensure they don't increase, it's time to decide who will be responsible for what debt. There are several ways to do this, including:
- If possible, pay off the debts now. If you have savings or assets you can sell, this is the cleanest method. You don't have to worry that your spouse will leave you responsible for his/her portion of the debt, and you can start your new life debt-free.
- Agree to take responsibility for the debts in exchange for receiving more assets from the division of your property.
- Agree to let your spouse take responsibility for the debts in exchange for receiving more assets from the division of property.
- Agree to share responsibility for the debts equally. Though at first glance this choice appears most "fair," it does leave both of you the most vulnerable. Legally, you are still responsible if your ex-spouse doesn't pay up, even if s/he signs an agreement taking responsibility for the debt.
Tax Issues in Divorce
People sometimes get caught up in the most obvious and talked about issues of divorce such as the division of property and debt, who will have custody of the kids, etc. As a result, many don't think through the tax implications of their divorce, an oversight that can cost thousands of dollars or more. This is where a certified public accountant (CPA) comes in very handy as a part of your divorce team. Tax issues that may arise from divorce can include:
- Who will get the tax exemption for dependents?
- Who will be able to claim Head of Household status?
- Which attorney fees are tax deductible?
- How can you be sure "maintenance" payments will be tax deductible?
- How can you avoid the mistake of having child support be non-deductible?
For a complete discussion of these issues, be sure to read 10 Divorce Tax Tips and Divorce and Tax Issues. Of course, as tax law changes and your unique situation may require special consideration, be sure to also consult a tax professional.
Retirement Plan Issues in Divorce
If your spouse has retirement savings, you are probably entitled, by law, to half. This money can be used for your own retirement or for a down payment on a house, relocation expenses, or other current expenses. To avoid the 10% penalty on early withdrawal, be sure to follow IRS regulations, as covered in Divorce and Retirement Assets: Getting the Money Without Getting the 10% IRS Tax Penalty. The primary issue with a division of retirement assets is that while the assets may or may not have been sufficient for your joint retirement needs, more than likely your individual retirement needs will be much greater. As a result, not only must you consider how these assets will be divided, but how you will continue to contribute to them in order to secure your financial future in retirement (even as your near future may be in question as well).
Divorce can bring out the worst in some people, and you need to be aware that even the most honest of people may try to cheat when it comes to settling up financially in a divorce. Spouses may under-report income, ask an employer to delay a large bonus or salary increase, among other dishonest behaviors. Most vulnerable are those whose spouse owns a closely-held business. The best defense when facing the financial concerns of a divorce is knowledge. It is particularly important for both spouses to educate themselves about their joint finances so that nothing remains a secret to be overlooked. In the case of divorce, ignorance is not bliss.
Other Resources for Financial Issues of Divorce
For more information on the financial concerns in a divorce, be sure to consult How to Deal with the Financial Impacts of Divorce.