While divorce can be emotionally difficult, it doesn’t have to mean financial devastation. In fact, there could be a silver lining that brings to light improvements in one’s financial well-being.
Detailing Cash Flow
The divorce process begins with a detailed inventory of each spouse’s income and expenses to determine the division of assets and any spousal support payments or child support. For some, this may be the first time they are examining their cash flow and assets in depth. The results of this exercise create a strong base of information for developing a financial plan for a new life as a single person. Not only will a financial plan help gain clarity for money management, but hopefully it will also find ways to create a surplus of income to invest toward goals, including retirement.
Developing a Realistic Financial Plan
Once you establish budget figures, it’s important to know the realistic level of earnings and assets required to support your income needs. Developing a financial plan that looks at current and longer-term needs can help you negotiate appropriate terms in a divorce agreement. Working with a financial advisor can be extremely helpful in establishing a strong financial path post-divorce.
Investment Accounts
Financial assets are often divided in some fashion between both spouses. While the value of the assets might appear to be equal, the underlying tax structure of accounts might not make them equal.
To make a settlement fair, the tax-adjusted value of accounts should be considered. Three prime categories of account types include the following, beginning with the most tax-punitive to the most tax-friendly:
- Traditional Retirement Accounts: These include traditional IRA and 401(k) accounts. Future withdrawals from these accounts are fully taxable thereby diluting their value. These assets hold the least value after taxes.
- Brokerage Accounts: Accounts such as individual or joint brokerage investment accounts are only subject to taxation to the extent that investments have appreciated in value. When an investment is sold, only the amount of gain is subject to taxes. Furthermore, capital gains are subject to a preferrable lower tax rate. As such, these accounts are more valuable and hold greater value than retirement accounts.
- Cash Accounts: Balances in checking, savings, and money market accounts do not have any inherent tax impact when you withdraw funds. The only taxes paid are on interest earned during the year. These are valuable assets to receive on a tax-adjusted basis.
- Roth IRA and Roth 401(k) Accounts: Roth accounts are the most tax-favorable because the investments grow tax-free while they are owned within the Roth account. Additionally, future withdrawals are tax-free.
Repositioning Your Investments
Once assets are divided, the investments you receive might not align with your investment needs and preferences. The accounts might need to be restructured. Creating new financial planning projections for yourself can help to determine appropriate investment positioning relative to your short-term and long-term investment needs.
Dividing Real Estate
Dividing a house can be one of the most challenging parts of a settlement. Often one spouse wants to retain the house but cannot afford it on their own. This is where a solid financial plan is helpful in determining the cash flow requirements for retaining a home. There can also be unexpected tax consequences of keeping a home when it is later sold for a gain. The tax-free capital gain exclusion for a single individual is significantly lower than for a married couple. Sometimes this can make it worth selling the home as part of the divorce settlement.
Creating an Insurance Safety Net
Creating a safety net for the unexpected is essential. This is especially true if one person was not employed while married.
A key first step is to evaluate insurance coverage and obtain new policies such as health insurance. Various options for help with medical expenses should be carefully considered. While an ex-spouse’s employer plan is an option under COBRA provisions, it is not a long-term solution, and perhaps not an economical short-term solution.
If there are minor children, additional life insurance may be needed for their protection. This could apply to insuring yourself, as well as possibly requiring your ex-spouse to maintain insurance coverage as part of the divorce agreement. The requirement for an ex-spouse to maintain life insurance can protect the need to replace future alimony and/or child support in the event of a premature death.
Additionally, long-term care insurance may be worth considering when a spouse is not in the picture to assist with elder care.
Updating Your Documents and Beneficiary Designations
There are a number of important personal administrative changes during and after a divorce. A few notable changes include updating common documents where your ex-spouse might have authority or rights that no longer align with your wishes. Common examples include:
- Health Directives
- Living Wills
- Power of Attorney documents
- Wills
- Trusts
- Beneficiary designations (commonly on life insurance and retirement accounts)
When going through a divorce, being proactive with financial decisions and consulting with professionals can help you dramatically improve your financial outcome. Having a financial planner on your team of experts can add invaluable guidance in helping you safeguard your finances. SageVest helps clients to navigate the financial impacts of all life events, including divorce. Please contact us to learn more about our services.
