Top 15 Financial Mistakes to Avoid in Your Divorce Settlement
Here are some financial mistakes to avoid when it comes to negotiating your divorce settlement.
Becoming a Financial Victim
The biggest mistake divorcing spouses can make is being in the dark about finances. If your spouse has always handled all of the financial decisions in your household and you don’t have any information about you and your spouse’s income and assets, your spouse will have an unfair advantage over you when it comes time to settle the financial issues in your divorce.
If you suspect your spouse is planning a divorce, get as much information as you can now. Make copies of important financial records such as account statements (eg., savings, brokerage, and retirement) and all other data that relates to your marital lifestyle (eg., checking accounts, charge card statements, tax returns).
If you believe your spouse may liquidate (sell or transfer to cash) assets or retitle marital assets without your consent, notify the holder of the asset or property in writing and get a restraining order from the court. Watch out for any cash held in joint checking and brokerage accounts, and the cash value of life insurance policies. If your spouse uses or moves assets without your knowledge, you may have to hire legal and forensic accounting experts to help you locate and value the assets.
Not Considering Mediation
If you and your spouse can work together to reach a fair settlement on most or all of the issues in your divorce (eg., child custody, child support, alimony, and property division), choosing mediation to resolve your divorce case may save thousands of dollars in legal fees and emotional aggravation. The mediation process involves a neutral third-party mediator (an experienced family law attorney trained in mediation) that meets with the divorcing couple and helps them reach an agreement on the issues in their divorce. Mediation is completely voluntary; the mediator will not act as a judge, or insist on any particular outcome or agreement.
Mediation also provides divorcing couples a lot of flexibility, in terms of making their own decisions about what works best for their family, compared with the traditional adversarial legal process, which involves a court trial where a judge makes all the decisions.
Mediation, however, is not appropriate for all couples. For example, if one spouse is hiding assets or income, and refuses to come clean, you may have to head to court where a judge can order your spouse to comply. Or, if one spouse is unwilling to compromise, mediation probably won’t work.
For more detailed information about the divorce mediation process, see Divorce Mediation Basics, by Emily Doskow.
Hiring a Combative Lawyer to Punish Your Spouse
This is a very bad idea for two reasons. First, except in extremely egregious cases, most courts won’t punish your spouse financially for being a bad person.
Second, hiring an attorney to punish your spouse will cost you because your attorney will need to increase the number of hours spent on your case. Increased attorney hours means higher divorce costs, and higher divorce costs means there will be fewer assets and cash left for you and your family. Try to take the emotion out of your divorce, and treat your case as a business arrangement. The best revenge is to live well after the divorce is over.
Failing to Recognize Your Common Enemy - the I.R.S.
Work together with a divorce financial planner or tax accountant to minimize the total taxes you and your spouse will pay during separation and after divorce; you can share the money you save. Don't forget that both spouses are liable for taxes due as a result of audits on joint returns, so it’s usually in your best interest to work together and minimize possible liabilities. If you’re facing complicated tax issues in your divorce, it’s best to consult with an experienced family law attorney and an accountant.
Not Producing an Accurate Budget
Divorcing spouses usually underestimate living expenses when they produce their initial budget for temporary alimony (also referred to as “maintenance”), and later find that they aren’t able to cover all of their bills. Use a financial professional to help you produce an accurate and complete budget.
Disregarding the Impact of Taxes in a Divorce Settlement
It’s important to remember that after the divorce is final, you may get taxed on the marital assets you received through your settlement. Say your spouse handles all the investments and offers to split them 50/50. Sounds good, right? The only way to know if you’re getting a fair deal is to determine the value of the investments on an after-tax basis, then decide if you like the deal. Again, you should speak with a tax professional about the impact of any proposed property division before you agree to it.
Failure to Evaluate Settlement Proposals
If you’re trying to decide whether your spouse’s proposed divorce settlement is fair and workable, you should try to figure out how the settlement will impact your finances in the years ahead. There are many factors to consider, including assets, incomes, living expenses, inflation, alimony, child support, taxes, retirement plans, investments, medical expenses and health insurance costs, and child-related expenses such as education.
There are specialized divorce computer models that produce comprehensive and realistic analyses of your post-divorce lifestyle. You should speak with a local divorce attorney or financial planner that specializes in divorce for help analyzing any proposed financial settlement.
Being Emotionally Attached to Assets in Divorce Negotiations
The marital residence, the pension you earned, a painting purchased during your marriage - these assets often bring an emotionally charged debate to divorce negotiations, which can impair good decision-making. Often, divorcing spouses that are attached to the family home don’t realize that they can't really afford. Yet, they fight tooth and nail to keep it, sometimes at the expense of retirement planning.
However, the real estate market crash has made it abundantly clear that homes have a very low return on investment and, in some cases, have a negative return; many houses today are still underwater, and couples have had to walk away from their homes and the hard-earned money they invested.
In addition, a home is a major cash expense (eg., mortgage payments, property taxes, repairs, and utilities). Let go of any emotional attachments you may have. During your divorce and settlement negotiations, your main focus should always be on how to maximize your finances by making sure you’ll have enough cash for living expenses after your divorce and in retirement.
Over-using Your Divorce Lawyer
Divorce attorneys generally charge $200- $300 per hour, and partners in well-known New York City, Los Angeles, and San Francisco family law firms typically charge $450 per hour. These attorneys can provide advice on divorce-related issues, but they are not therapists or certified financial planners. If you need to talk through the emotional aspects of your divorce, or need career counseling or financial analysis, save money on additional attorney’s fees and be sure to talk to the right professionals, such as a licensed therapist, vocational expert, or a financial planner.
Beware of Settlement Offers That Look Too Good
Both spouses and children must make compromises in their life styles post-divorce. A settlement that does not give one spouse enough money to live on is likely to go into default in the future. Be fair, but verify the numbers. Get payments up front whenever possible, even if you get less in total. Try to secure all payments with assets and insurance. It may be worth speaking to a family law attorney who can review a settlement offer and make sure your rights are fully protected.
Disregarding the Long Term Impact of Inflation
The effects of inflation on the cost of a child's college education, or on retirement, 15 years in the future can be dramatic. The “Rule of 72” is a simple way to judge the impact of inflation. For example, if the inflation rate is 3%, the “Rule of 72” means that prices will double in 24 years (72/3=24). College costs at 5% inflation will double in 14.4 years (72/5=14.4). Be sure to work inflation into your settlement negotiations so you can cover the true costs of future financial expenses.
Failing to Consider Your Spouse’s Eligibility for Social Security Benefits
If a couple is married for 10 years or longer, a non-working or lower-earning spouse is entitled to derivative social security benefits on the higher earning spouse’s (“worker spouse”) record. These derivative benefits do not impact or lower the worker spouse’s social security payments, which is why it's so ironic that the average length of marriage for people who get divorced is about nine and a half years. Waiting just another six months may guarantee increased retirement options with no reduction in payments.
For more information on this topic, see Social Security Benefits After Divorce by Lina Guillen.
Forgetting to Update Estate Documents
After divorce, many people forget to change the beneficiaries on their life insurance policies, IRAs, and will(s), so the estates they wanted to leave to their children, new partner, or favorite charity may go instead to their ex-spouse. If you’re going through a divorce, talk to a family law attorney to find out what changes you can make to your estate plan during and/or post-divorce.
Failure to Adequately Insure the Divorce Settlement
Your ex-spouse’s premature death or disability can be devastating and may result in a loss of alimony, child support, college tuition, or property settlement payments. Life and disability insurance policies can guarantee that these payments will continue despite an unexpected loss or injury.
Failure to Develop a Post-Divorce Financial Plan
One indisputable fact of divorce is that two households cost more to operate than one. Many divorcing spouses fail to realize that their divorce settlement must last a significant amount of time: perhaps even the rest of their lives. Financial planning can help people transition from a married to single lifestyle by prioritizing financial goals, developing realistic expectations, and producing sound plans for the assignment and division of financial resources.