Divorce can be one of the most emotionally taxing events in a person’s life, and its financial implications can often add a significant layer of stress. Divorce settlements affect everything from your long-term financial stability to your lifestyle, retirement planning, and even your credit score. While the emotional aspects of divorce tend to dominate discussions, the financial side is just as important, if not more so, to your future well-being.
In this blog post, we’ll explore key financial considerations that financial experts wish everyone knew about divorce. From understanding the financial impact of divorce to making smart decisions about asset division, we’ll cover a range of insights that can help you navigate this challenging time with more clarity and confidence.
1. Divorce Can Have Long-Term Financial Consequences
Many people focus on the immediate impact of divorce: how assets will be divided, whether maintenance or child support will be paid, and who will keep the family home. However, financial experts stress that the long-term financial impact can be even more significant. A divorce can set you back in several areas, including retirement savings, investment portfolios, and credit ratings.
In many divorces, one of the most substantial assets to be divided is retirement savings. Pensions, 401(k)s, and other retirement accounts may need to be divided between spouses, depending on the laws in your state. If you’re the higher-earning spouse, you might have to part with a portion of your retirement savings, potentially setting back your ability to retire on your preferred timeline.
Divorce can also affect your credit score. If your ex-spouse was responsible for managing the household’s finances, you may be unaware of existing debts or missed payments. Furthermore, any joint accounts that are not properly closed or settled can hurt your credit score.
If one spouse took a break from their career to raise children or support the household, they may face a significant earning potential gap after the divorce. Financial experts often suggest looking at the long-term income trajectory for both parties when deciding on maintenance or child support to ensure fairness.
2. It’s Crucial to Understand the Value of Your Assets
One of the most common financial mistakes people make during divorce is underestimating the true value of their assets. It’s essential to fully understand what you and your spouse own, and that includes everything from real estate to retirement accounts, business interests, and even personal property.
The family home is often the most emotionally charged asset in a divorce, but it’s also one of the most significant financial decisions you’ll make. Financial experts recommend evaluating whether it makes sense to keep the house. While it may seem like the obvious choice, it may be more financially prudent to sell the property and divide the proceeds, especially if one spouse cannot afford to maintain the home independently.
If one or both spouses own a business, it can be difficult to determine its value. In these cases, experts recommend hiring a professional business valuator. A business’s value can fluctuate based on various factors, including market conditions, intellectual property, and customer contracts, so a thorough valuation is essential to avoid an unfair division.
Some spouses may try to hide assets during a divorce to minimize the financial settlement. Financial experts suggest hiring a forensic accountant to track down hidden funds, assets, or income sources. These professionals specialize in tracing financial transactions and uncovering discrepancies that may indicate hidden wealth.
3. The Importance of Tax Implications
Taxation is another area where divorcees can make costly mistakes. Divorce settlements can trigger significant tax consequences, and understanding these implications is essential to making informed decisions. For example:
In the past, maintenance payments were tax-deductible for the paying spouse and taxable income for the receiving spouse. However, following the Tax Cuts and Jobs Act of 2017, this rule changed for divorces finalized after December 31, 2018. Maintenance is no longer deductible for the payer or taxable for the recipient.
When dividing assets, such as retirement accounts or investment portfolios, you’ll want to consider the tax implications of withdrawing from these accounts. For instance, if you are awarded part of your spouse’s 401(k), you’ll be responsible for taxes when you withdraw the funds. It’s also important to factor in capital gains taxes when selling appreciated assets like stocks or real estate.
Child support itself is not taxable income, but the parent who claims the child as a dependent on their tax return may receive valuable tax deductions. Experts recommend agreeing on which parent will claim the child to avoid confusion or disputes during tax season.
4. Understand the Divorce Process and Financial Settlement Options
Divorce can be complex and often involves negotiations and legal processes that require careful financial planning. Financial experts stress the importance of understanding the various settlement options available, as well as the potential tax and long-term financial consequences of each.
When dividing assets, some individuals may opt for a lump-sum payment, while others may choose to receive payments over time. A lump-sum payment provides immediate financial relief, but it also means you will need to manage and invest the funds wisely. On the other hand, ongoing payments, such as maintenance or child support, can provide more long-term stability but may create financial dependency.
If part of the divorce settlement involves dividing retirement assets like a 401(k) or pension plan, you will likely need to obtain a Qualified Domestic Relations Order (QDRO). This legal order ensures that the retirement plan is divided fairly without incurring early withdrawal penalties or taxes.
Sometimes, instead of dividing assets like retirement accounts or savings, one spouse may agree to “buy out” the other spouse’s share of the property or assets. This can be a good solution if you wish to keep specific assets (such as a home) but can’t afford to divide other assets.
5. Maintenance and Child Support
Maintenance and child support are common in divorce settlements, but their financial impact can be profound. It’s important to look beyond the initial amount and consider how these payments will affect your future financial situation.
When maintenance is awarded, it is often based on factors such as the length of the marriage, the recipient’s financial need, and the paying spouse’s ability to pay. Financial experts advise individuals receiving maintenance to plan for how they will support themselves after the payments stop, which occurs upon remarriage or the death of the payor or (if agreed to as part of the settlement) after a set number of years. For the paying spouse, it’s crucial to consider how maintenance will affect long-term financial goals, including retirement planning.
While child support is intended to cover a child’s basic living expenses, including food, housing, and education, it is also subject to change based on the child’s needs or the parent’s income. Child support may be modified if circumstances change, such as a significant increase or decrease in either parent’s income, or if the child’s needs change.
6. Prepare for a New Financial Reality
A major financial shift typically occurs after divorce. Whether you’re living on a single income for the first time or managing new financial obligations, it’s crucial to adjust to your new financial reality. Financial experts recommend the following steps:
Adjust your budget to reflect your new income and expenses. Be sure to factor in new costs that might arise, such as child support, maintenance, or medical insurance premiums. You may also need to update your housing situation, whether it’s selling a family home or moving into a new rental.
Divorce often involves dividing debt in addition to assets. Both spouses are typically responsible for debt incurred during the marriage, even if the debt is divided. If you’re the one taking on debt, create a plan to pay it off as quickly as possible. Seek professional advice if you’re struggling with the debt division process.
Divorce can significantly affect retirement plans. If your retirement accounts are divided as part of the settlement, you may need to adjust your savings strategy. You might need to increase your contributions to catch up on what you lost or consider adjusting your retirement age.
7. Get Professional Financial Advice
Lastly, and most importantly, experts recommend hiring a financial advisor who specializes in divorce. While many people think they can navigate the financial aspects of divorce on their own, divorce is complex, and small missteps can have long-lasting consequences. A financial advisor can help you understand your financial picture, set realistic goals for the future, and help you make informed decisions that protect your financial future. A certified divorce financial analyst (CDFA) is a professional trained specifically to help individuals navigate the financial complexities of divorce. They can provide insight into tax consequences, asset division, and long-term financial planning.
Divorce is a challenging and emotional process but understanding the financial implications can help you make better decisions and protect your future. Financial experts emphasize the importance of planning ahead, understanding the value of your assets, and considering the long-term consequences of your financial decisions. With the right information and professional support, you can navigate the financial side of divorce and ensure that you’re on a path toward a secure financial future.
Should you need the assistance of an experienced divorce attorney in Creve Coeur and O’Fallon or have questions about your divorce situation, know that we are here to help and ready to discuss those questions with you.