It’s right up there with death of a spouse for the most stressful life events we can experience. Yet just as you cannot escape the paperwork and financial issues after the death of a loved one, you can’t afford to ignore the financial aspects of a divorce, as you are setting the foundation for the next chapter in your life. As difficult as this time is, and regardless of which side of the divorce you are on, you must keep good records and clear thoughts.
First things first
The first task is to gather copies of records, documenting what you own and what you owe. As with all things in a divorce, if you and your spouse are able to collaborate and work together, this will be easier than if you have to hunt for things on your own, especially if you don’t know what to look for.
A good place to start is with the tax return. A tax return tells a lot about a person’s finances, from income to housing costs. Schedule B should show you where you’ve earned interest and dividends, so you can track down those statements, and Schedule D (if any) leads to more investment statements. The return may show an IRA deduction or you may see a “D” on a W2, leading you to a retirement account deferral. You’ll also need that tax return itself, to document earnings and project taxes.
In order to have a clear understanding of your financial position post-divorce, you’ll need to know what it costs to live. Even if you kept good track of your spending pre-divorce, your new life as a single person is likely to be quite different. Especially if you are weighing whether to keep your house, it is vitally important to know the costs.
This is a time where it pays to track the details of your daily spending. Your system can be as low tech as carrying a small notebook to record your purchases and bills. Look over a calendar to jog your memory for expenses that don’t come up every month like birthday gifts, sports fees or seasonal clothing purchases. Some of your expenses will go down, simply because your household is smaller, but you’ll have some increases, too.
You may need to hire someone to do chores that your spouse previously took care of, or perhaps pay for your health insurance premiums. Will you be inclined to take the kids out more often to “make up” for the divorce or perhaps paying for counseling to work through that guilt instead?
Closing the gap
Once you have a grasp on what it will take to run your new household, the challenge will be to fund it. The income pool you shared previously will now essentially be stretched to cover two households. Unless you had a large surplus of income pre-divorce, likely either the standard of living for one or both households will go down, new income will need to be generated, or both.
When determining how much income or support is needed, you’ll need to consider the tax treatment of that income in light of your changed financial situation.
A custodial parent may find that with her lower income, she has more to take home because of a light tax burden, or on the other hand, the higher earning spouse may now have less in hand due to the loss of tax deductions. It is important to have good tax advice so you can make decisions knowing the full impact.
Splitting up the stuff
The biggest decision in dividing assets in divorce usually is — “Who gets the house?” But perhaps the question should be — “Does keeping the house make sense?” Anyone who has ever owned a house knows that a house is an asset that costs you money, and sometimes a lot of it. If you are the spouse considering staying in the house, can you afford not just the mortgage and taxes, but the upkeep of the house? Do you have the means (and credit) to refinance to take your spouse off the mortgage? If you do, then great!
But this is one decision that is fraught with emotion, and it pays (literally) to take a step back and look at it objectively. Keeping your kids in the house for the sake of continuity is important, but will it be worse for them if you struggle to pay the bills, work too much, and are too stressed to enjoy your time with them?
Aside from the house, the next largest asset couples typically need to split is retirement accounts. To avoid unintended tax consequences, it is critical to have legal and tax advice in splitting these assets. For instance, there is a way to withdraw retirement assets without paying an early withdrawal penalty when done correctly with a Qualified Domestic Relations Order. But the rules must be carefully followed or you could end up with that 10 percent penalty, or the wrong spouse could be subject to the tax.
When evaluating assets and how to divide them, be mindful of the character of the assets — amounts in traditional retirement accounts typically have not yet been taxed, and will be worth less to you upon withdrawal than money in a savings account. So watch the price tag and weigh accordingly.
In a contentious divorce, spouses may get caught up in either getting the most support or share of the assets possible from the other, or in paying the very least, without considering how the outcome may affect the family overall. Especially when kids are involved, leaving one spouse or the other broke does not serve the family well. A different solution is approaching the divorce in a collaborative manner, working together to determine the optimal overall division of income and assets, as well as resolving the myriad of family issues that come with divorce, while minimizing conflict and emotional damage.
In the collaborative divorce, the spouses commit to a process of focused negotiating sessions to share information, work out concerns, and come to agreement. Collaborative divorce is different from mediation, as each party is still represented by his or her own independent attorney, but the objective is to work together to achieve the best possible outcome for all involved, rather than fighting it out. The addition of a mental health professional and financial specialist to the team offers neutral, objective advice to the family.
Erin Baehr is a certified financial planner and owner of Baehr Family Financial, a fee-only financial planning firm in Stroudsburg (www.YourMoneyEveryday.com). Baehr can be reached at 570-223-1550 or at Facebook.com/YourMoneyEveryday.