There are many financial planning considerations before, during, and after a divorce. A key part of the process from a financial standpoint is the division of marital property. Many divorcing spouses tend to look at the total sum of the property being received and whether that sum is equal. However, the total sum may be misleading as some marital property assets are much more favorable from a tax perspective than others.
Below are some key considerations when financial planning for a divorce.
1. Team of Professionals
When getting a divorce, determine who you need on your side. Do you need to assemble a team of professionals to help you? During the process, you should consider your divorce attorney as the most important part of your team. But you should also consider whether you need a financial advisor, a tax advisor, and an estate planning attorney. In some high-asset divorce cases, getting a complete list of the marital assets to be divided can be challenging. Was there a secret bank account or credit card that you didn’t know about? In such cases, you may need a forensic accountant to review bank, securities, and other financial statements to make sure all marital assets are accounted for at the end of the case. Further, during the asset division process, a financial advisor can help advise you on what marital assets would be most favorable to receive a divorce. Do you know the tax implications of the different marital property assets you could receive? If not, then prior to negotiating a settlement or proceeding to trial, a tax professional can help you decide which marital property assets have the highest after-tax value.
2. Tax Consequences
How different assets received at divorce are taxed post-divorce is very important during settlement negotiations or presentation at trial. Money in a retirement account is usually fully taxable as regular income (unless in a Roth IRA when funds can be tax-free when holding periods are met). Securities investments held in a brokerage account are usually only taxable above their cost basis (i.e., the original purchase price of the stock, bond, mutual fund, or ETF). Securities investments held in a brokerage account are then taxed at long-term capital gains tax rates or short-term capital gains tax rates when sold. Cash has no tax implications. You may also need to consider any tax considerations when deciding whether to keep or sell the marital home at divorce.
3. Important Considerations
What do you want your life to look like after the divorce? Splitting up your marital property during a divorce may seem like it’s only about dollars and cents, but it shouldn’t be. In deciding what marital property you want to keep post-divorce, consider how that property fits into how you’re envisioning your post-divorce lifestyle. Do you envision being happy staying in the marital home? Where are the children living? Are you keeping a pet? What securities and investments match your financial goals and risk tolerance? How much liquidity (e.g. cash) do you need to fund your new post-divorce lifestyle? Take the time to better understand the income you’ll need to maintain your current lifestyle.
Liquidity and Cash Flow Needs
It is important for you to know the liquidity of the marital property being divided. Real estate isn’t liquid until sold, so if you are keeping the marital home then you will need to make sure you can cover expenses with other marital property received in the divorce.
To divide a workplace retirement plan like a 401(k), 403(b), or a pension plan, a court-issued document called a qualified domestic relations order is required. Your attorney must prepare the QDRO and there is a cost for your attorney to do so post-divorce. In contrast, the division of an IRA is completed through a trustee-to-trustee transfer form that is completed by the financial institution holding the account.
When you are awarded real estate at the end of the divorce, your former spouse can’t remain on the mortgage. To keep the property, you will need to pay off the mortgage or refinance it into a new loan only in your name. This could be through a refinance process or through an assumption with the current mortgage holder. So it is very important to make sure you can qualify on your own for a refinance or an assumption before negotiating a settlement or proceeding to trial.
Stock Options and Equity Compensation
There are many factors to consider when dividing stock options, grants, or other awards in a divorce. The first is what portion of the equity compensation is marital property subject to division by the court. What options and interests have already vested? What options and interests may vest subject to a vesting schedule and other scheduled benchmarks? Should you treat already vested stock as marital property subject to division? Should you treat any future vesting interests as income for purposes of support? Make sure your attorney is familiar with complex compensation structures so that he or she can work with you to determine the most appropriate treatment of stock compensation or equity ownership. Even if you and your spouse agree on the shares to include as marital property, valuation can be a challenge if the company is private. Further, most stock plan documents prohibit the transfer of equity compensation, which poses hurdles for a quick and easy division. Understanding the tax consequences and having language in an agreement that addresses those consequences is particularly important for the equity holder as exercises/sales are taxable to the employee spouse personally.
What are the marital assets? The two divorce attorneys must agree on what assets are part of the marital property asset pool to be divided. Are there any commingled marital property assets? Look for documents that could provide relevant information, including when the asset was acquired. Do you have a prenuptial or postnuptial agreement? How is each marital property asset titled?
Is there an inheritance received during the marriage? Is a current or future inheritance received during a divorce? Did you keep the inheritance received in a separate account? Did you retitle your separate inheritance property into joint names with your spouse? Of course, there are many other aspects of inheritance and divorce to consider and discuss with your attorney, but it should be on your radar.
Should you need the assistance of an experienced divorce attorney, or have questions about your situation, know that we are here to help and ready to discuss those questions with you.