A significant issue in divorce, retirement savings often makes up a substantial amount of a marital estate, particularly for couples who have been married for ten years or more. However, most spouses do not seem to realize the financial impact on retirement until it is almost too late.
In general, a two-income household works to save retirement funds for the couple to retire together, and therefore budget accordingly. When this couple divorces, those plans go completely out the window, because they now must each plot a new path forward where each spouse must have a residence of some type, fixed expenses, and some “play” fund. With essentially half the proposed saving, the revised plan will be much different than imagined.
In a household with only one income, the spouse not earning income must rely on the savings of the other spouse; without it, that spouse faces a potentially dire financial future at retirement.
The mistake most spouses make during a divorce is to access retirement funds to pay for lifestyle during the divorce or to pay other bills. First, most local rules of court prohibit using any marital assets without the written approval of the other spouse. Second, draining retirement funds, even as a loan against it, comes with costs not factored into the calculation of withdrawal. For example, if a spouse removes $25,000, that sum will be subject to an early withdrawal penalty of 10% and is taxable as income so the marital estate as a whole loses not once but twice. If the spouse takes a loan of $25,000, that sum carries an interest rate that may be high, have quick repayment terms, and also may deplete the fund for continuous earnings. So, again, the marital estate loses twice.
The next big mistake spouses make involves underestimating the value of retirement funds, particularly when only ten years removed from retirement. If a spouse loses half of her retirement fund to the other spouse, the earning capacity of the whole fund drops by more than half because it would have earned so much more as a whole. Replacing that lost investment income will be impossible for most spouses, so some lost future income will result. If the spouse does not plan for the lost income or come up with a plan for retirement, when retirement hits the spouse will find she lacks the overall income to support the intended retirement lifestyle.
The most sensible move during divorce is to consult a financial planner and walk through options where you retain different amounts of retirement income post-divorce. Which gives you the path closest to the retirement you envision? What lifestyle changes must you make in the short term to still have that retirement? Are you fully covered in the event of illness? Have you taken account of the amount of Social Security income you will receive, whether through your income or that of your spouse (if it is higher and you were married for at least ten years)? Without answers to these questions, you will not be in a position to negotiate a good settlement to the marital estate.
If you have questions about divorce and retirement, contact us – we can help.