Jan 25 2023

What to Know: Financial Planning for a Divorce

For many couples, no amount of therapy, date nights, chocolate or flowers is enough to keep their marriage going. When divorce becomes the only option, it’s important to start planning because the process is often emotional.

That’s especially true when it comes to handling the financial aspects of divorce. You can get caught up in all the legal negotiations and miss things that eventually turn into costly mistakes.

The fact is the cost of a divorce can far exceed just attorney fees. And, while conventional thinking tells you that ex-spouses split everything 50/50, the financial impact of divorce is often unequal. Consider that one study found that women aged 50 and older who divorced experienced a 45% decline in their standard of living, whereas men’s dropped by 21%.

The way I look at it is: divorce is not something you plan for, but it is something you need to start planning for when you see signs of real trouble. The financial planning moves below can help reduce your uncertainty and stress by putting you in a better financial position before, during and after.

I know each divorce, as is every marriage, is unique. Even if you are on the best of terms with your future former spouse, preparing and planning for all the financial aspects of divorce – including the “what if”’ scenarios – is vitally important for keeping your financial life together. 

Partner with a financial advisor who has divorce expertise

Divorce has a lot of moving parts. That includes a variety of financial assets, including cash, retirement accounts, investments, real estate or equity in a business. It’s unlikely your attorney will be knowledgeable about the details and the value of these assets or their tax consequences. 

For instance, your attorney might be able to fight for you to keep the family home without realizing your ex would then receive other assets, such as company stock options that could be worth three times the value of your house. Sometimes, you don’t find out the real value of assets until after the divorce has been finalized.

This where the right fiduciary financial advisor can offer expertise on a divorce’s impact on your current and future financial well-being. Throughout the divorce proceedings, an advisor can help identify what assets you’re entitled to, navigate tax rules and stay on top of important deadlines for transferring funds. 

To ensure your best interests come first, focus on finding an independent, fee-only advisor who must act as a fiduciary at all times. There are advisors who specialize in helping clients through divorce, such as those who are a Certified Divorce Financial Analyst (CDFA). A CDFA can work with you to first determine the potential cost of a divorce and then provide guidance on structuring your settlement. 

You may be thinking a financial advisor is only going to make an already expensive process even more expensive. But the cost could pay for itself and more in helping you avoid costly mistakes and even shortening the legal process with efficient planning.

Gather important financial documents

You need to provide a variety of financial documents to arrange a divorce settlement. But equally as important, some of these documents will be helpful in managing your finances post-divorce.

Key financial documents you’ll need to gather include:

  • The most current statements of all accounts (bank, checking, savings, credit cards, investment, retirement plans, etc.)
  • Statements pertaining to any loans (mortgage, auto loans, personal loans, etc.)
  • Pay stubs or W-2 income statements 
  • Tax returns for the last three years
  • Titles to property (homes, cars, boats, etc.)
  • Insurance policies (including life, health, property, etc.)
  • A copy of your credit report and credit score

For additional documents, checkout this handy checklist from the Institute for Divorce Financial Analysts.

Beware: not all financial assets are treated the same

As you start taking stock of what assets to divide, it’s important to know that not all of them are equal. 

For example, $1,000 in cash is not equal to $1,000 in stocks. The value of those stocks can change and you may have to pay taxes when you sell them. 

Assets like investments and real estate are taxed based on when they were purchased, the initial purchase price and the sale price. This is known as their cost basis. To ensure an equal distribution of these assets, you will want to discount the value of each asset based on the size of the taxes due. 

This is another area in which a financial advisor can serve as a valuable resource.

Divide retirement accounts carefully

It’s likely that you and your soon-to-be-ex will have to divvy up your 401(k)s or other workplace retirement accounts. This is often the case among older adults, when retirement savings make up a large portion of their combined wealth. 

There are certain rules to follow or you risk the IRS hitting you with insult to injury – that is, tax penalties. For example, if you split your 401(k) by simply withdrawing half the funds, you would be subject to a 20% withholding tax. And, if you’re under age 59 ½, you may also have to pay a 10% early withdrawal tax penalty. 

For equally distributing retirement accounts without the tax burden, your attorney needs to draw up a Qualified Domestic Relations Order (QDRO) for each account. Essentially, QDROs set up the transfer of funds from a retirement account to you or your ex.

The funds can be transferred into rollover IRAs for each of you without taxes due, as long as it happens within 60 days. Funds can also be distributed directly to you or your ex without the 10% early withdrawal penalty, but ordinary income taxes would apply. 

Sorry to sound like a broken record: this is a scenario where a financial advisor can make sure you adhere to the divorce agreement and meet any critical deadlines for distributing funds. 

Stay on top of your bills, credit and debt obligations

Unfortunately, bills don’t care about what’s going on in your personal life. 

Throughout the divorce process, you will want to make sure bills you’re responsible for are updated with your name only and are paid on time so you can maintain a good credit score. Also, don’t forget to pay any taxes and file tax returns on time.

This is important to ensure a solid financial footing as you become single. If you have good credit, you may want to open a credit card in your name if you don’t have one.

Untangle shared accounts and update your beneficiaries

This is where most people often make mistakes. 

You want to close all shared accounts and update those you plan to keep open with your name only. This includes all debt issued in both names, such as mortgage, credit cards, auto loans, etc.

Consider that if your former spouse goes bankrupt or stops paying on a debt, you will be liable for the debt. Even if you divorce amicably and are on friendly terms, you’ll never be 100% certain your ex won’t take a wrong step that ends up affecting you financially. 

For example, I had a friend who went through a friendly divorce. But then her ex-husband started a business by maxing out a credit card they shared and never closed. He eventually couldn’t pay off the balance. Don’t be my friend.

While you’re at it, be certain to update beneficiary designations on insurance policies, retirement plans, IRAs and annuities as appropriate. These designations override your will. So, it could create a messy situation if you were to remarry and still have a former spouse listed as a beneficiary. 

Budget for your divorce and post-divorce life

The average total cost of a divorce is around $12,900, according to the legal website Nolo.com. However, divorces without lawyers are much cheaper. How much can you set aside?

Be realistic about what you can afford. If you don’t have enough money saved to hire a divorce attorney and pay any related expenses, you might be able to get your spouse to agree to spending an equally conservative amount. If that doesn’t work, you may want to seek a legal separation, which stipulates how you both use money until the proceedings end.

Before your divorce is finalized, consider creating a budget for your single life. The post-divorce transition can be quite the financial adjustment, and you don’t want to get caught off guard by unexpected expenses. You can review your past spending to help get you started, but consider future expenses that reflect your changing circumstances. Certainly, if you gain custody of your children, you have to factor in the cost of child care, extracurricular activities and eventually college tuition.

Also, don’t forget to reevaluate your long-term financial goals. How does saving and investing for retirement change for you? Do you need to start saving more? 

Hopefully, these steps help you see that this is not necessarily the end of something, but rather the start of something new, something that can be better. 

The relationship therapist Eshter Perel said, “Today most people are going to have two or three marriages, two or three committed relationships in their adult life. It’s just that some of us are going to do it with the same person.” 

All of us are going to have multiple financial lives, all with the same person. Ourselves. Make your next one the best one yet.

Finding the right financial advisor can be challenging. Let Wealthramp help you find the right advisor who will help you with your personal financial needs and situation.

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