10 Common Money Mistakes in Divorce

Mishandling matters incident to a divorce can be costly. These are some most common errors:

1. Lack of Communication with your spouse.
   One of the biggest problems is trying to identify and gather information. Many times, the spouse with the most financial expertise will often handle documents, transfer assets, not disclose information, etc. Couples who are forthcoming and transparent with all the financial information find that their divorce is resolved cost-effectively. It also helps the family to retain a sense of dignity during this difficult time. Assets will be found – it just takes time and your money.
2. Understanding that the wife should Not always get the house.
   Many women count on support to pay a very high house payment; often times more than the amount they could rent for.   This does not make good financial planning sense. One can never count on support 100%. If, in a few years, she cannot afford to keep the house, she may lose money due to taxes and selling costs that were not considered at the time of divorce.
3. Ignoring cost basis in property and non-retirement plan assets.
   Sheila wanted to keep her dream house after the divorce. They had paid $190,000 for it 20 years go and it had appreciated so much that it was now worth $690,000. But after a few years of being single in a large house that needed lots of repair, she decided to sell the house. After considering costs and improvements that had been done over the years, the taxable capital gain on the sale of the home was $560,700. She could deduct her $250,000 exclusion, but she ended up owing over $77,000 in federal and state taxes! If this had been considered at the time of divorce, it could have been structured so they may have taken the full $500,000 exclusion and/or had a different conversation about the tax bill.
4. Not insuring support.
   Since support usually stops upon the death of the payor, the stream of payments can be covered by life insurance on the life of the payor if there is no other adequate source of security for the future stream of income. This may be part of the final divorce settlement.
   We always recommend that the beneficiary own the life insurance policy and make the premium payments. This prevents any changes in the policy without knowledge.
5. Not understanding the 72(t)(2)(C) section of the tax code.
   This IRS rule says that any monies coming from a qualified plan to the non-employee spouse can be spent without incurring the 10% penalty even if this person is under age 59 1⁄2 . Taxes will need to be paid on it. (Note: An IRA is not a qualified plan.) If the monies are transferred from the qualified plan of the working spouse to an IRA for the non-working spouse, and then a portion is withdrawn, the 10% penalty will then apply in addition to taxes. It’s all in the timing.
   Example: If Melissa, age 42, is awarded one-half of Jason’s 401k which is worth $420,000, Melissa, with a QDRO, can take all of her $210,000 in cash if she wishes. Since this will go into her taxable income for that year, she may wish to take a smaller amount to meet her immediate needs. She will need to pay taxes on the $210,000 but will not have to pay $21,000 in penalties for early withdrawal. If she were to take a smaller part, say $80,000, she would save $8,000 in penalties for early withdrawal. It is recommended to transfer monies to an IRA unless liquidity needs take priority .
6. Not understanding the purpose of a QDRO.
   The Qualified Domestic Relations Order (QDRO) is an order from the court which, among other things, tells the plan administrator what amount (either percentage or dollar amount) is to be given to the non-employee spouse pursuant to the divorce. Some plans do not allow for a QDRO! And the pension plan takes precedence over a court ruling. The plan documents need to be read to ascertain how that company handles a division of retirement assets in the case of a divorce. A QDRO should only be prepared by an attorney or someone who specializes in QDROs.
   Key areas to be aware of:
   1. Death of either Party. What will happen if either party dies before the non-employee gets the whole share of the pension? A QDRO can either miss this issue completely or get it wrong.
      
   2. Not having the QDRO approved before the divorce is final. If the employee dies after the divorce and no order is in place, the ex-spouse may lose every bit of the interest in the retirement. This is because the non-employee is unprotected during the period between the divorce and QDRO approval. And, if the employee had remarried, the new spouse will receive all the survivor benefits. (A remarriage often happens due to the long delay sometimes in getting a QDRO submitted and approved!). It is possible to obtain a “pre-approval” of a QDRO.
      
   3. Failing to Consider Early Retirement. There are some retirement plans that offer a substantial bonus to employees who retire early. This should be considered and thought should be given to negotiating for a portion of it, or not dividing it in exchange for some concession or property.
7. Violating the front loading of Spousal Support rule (for older taxable support agreements).
   An IRS rule says that if the taxable support is more than $15,000 per year and the payor of maintenance wants to deduct the whole amount, taxable support needs to be paid for at least 3 years. The amount can change. But if it drops by more than $15,000 from one year to the next during the first three years, there will be tax-recapture on the excess.
8. Not engaging a trained Divorce Financial professional.
   You have help out here! Financial professionals (CDFAs, CPAs, attorneys, and financial planners) are being trained in the intricate financial aspects of divorce. They know the tax loopholes and show the estimated long-term financial result of any given settlement proposal. This gives you more information that helps you come to a better solution for both parties involved.
9. Not hiring a Family Law attorney.
   Divorce law is so different from other areas of law that even those lawyers who specialize in it find it difficult to keep up with all the changes that happen constantly. However, they do have more knowledge in the intricacies of divorce than other lawyers. We recommend you do not use the friend next door, the acquaintance at church, or the corporate attorney, unless they are experts in family law. You may find yourself later hiring a divorce lawyer just to fix the mistakes of the first lawyer .
10. Overlooking the importance of protecting your credit.  Knowing your credit score and how to improve it will help maintain financial strength and your borrowing  ability.  Review credit reports to stay current and help identify fraud. Use strong passwords and  be aware of information you give out.

Summary

Divorce isn’t something that happens to “other people” anymore. In fact, there are about 1.2 million divorces every year in the United States. That’s at least 2.4 million people who must face the challenges a breakup can cause, not counting children, in-laws, relatives, and friends.

Given the fact that divorce can and does happen, the solution is often not to prevent divorce but to help the process and the settlement be as respectful, fair, and as pain-free as possible.