During a divorce, you'll be faced with many decisions that may affect your financial security. This article outlines the most common financial mistakes divorcing spouses make and provides tips on how to avoid them. You may feel comfortable dealing with some of these issues on your own, but with many of them, it's crucial that you find good financial advice from a qualified professional.
1. Ignoring or underestimating your expenses. Most people know exactly what they earn each month, but can't explain where their money goes. Take the time to write down all of your expenses, and develop a realistic monthly budget. Likewise, consider the cost of your future living expenses, taking inflation into account. If you ignore inflation, you may underestimate your future needs and find that you're not able to maintain your quality of life.
2. Believing that the parent with more custodial time should keep the family home. It's often a very emotional decision whether to keep the family home, especially when children are involved. While it would be nice to remain where you're comfortable and avoid the hassles of moving, staying put might not be the best financial decision. No matter how attached you are to your home, it's critical to have a realistic sense of whether you can afford it. If you give up everything else in order to keep the home, and then find that you can't cover the mortgage, property taxes, and maintenance, you may end up in serious financial trouble.
Learn more about this issue in What to Do With the House When You Divorce, by Emily Doskow.
3. Assuming that an equal division is a fair division of property. Be sure you understand that an asset's value is not necessarily defined by or limited to its current market value. For example, assets that generate income (like rental property or bonds) may be worth more than their market value. Agreeing that each spouse will receive property of equal monetary value doesn't always mean each spouse will receive a truly equal share of the assets over time. Make sure you're comparing apples to apples when you trade assets in a divorce negotiation, and pay attention to tax basis, present value, and transaction costs.
Learn more about this issue in Divorce & Money, by Violet Woodhouse with Dale Fetherling.
4. Deciding financial issues one at a time. By looking at each asset or source of income separately, you miss the interaction of taxes, capital gains, investment losses, timing issues, inflation, and more. A fair settlement begins by looking at a comprehensive picture of all of your finances. Once you've done that, you'll be better able to understand how each financial decision you make may affect another decision, and determine how and when to divide assets.
5. Failing to secure spousal support (alimony) and child support payments with insurance. Your ability to collect alimony and child support is only as good as your spouse's ability to pay. You can request that your spouse obtain disability and life insurance policies (or modify existing policies) to ensure that these payments will continue in the event of your spouse's disability or death. Be sure to review the policies to make sure your spouse has made the proper designation(s). Understand that these policies won't help you in the event of your spouse's voluntary decision to stop paying. To enforce your rights in this situation, you'll need to go back to court and ask for an order that your spouse make the appropriate payments.
6. Not understanding your liability for unsecured debt. For most people, unsecured debt means consumer credit card debt. In most cases, if the debt was incurred during the marriage, it's a shared liability no matter which spouse used the credit card. When you settle your divorce, you'll divide responsibility for those debts. But don't assume that the credit card companies care what your settlement says - they can still come after both of you for payment. The best practice is to pay off all debts before the divorce becomes final.
7. Not evaluating a defined benefit pension plan correctly. A defined benefit plan (DBP) is a true pension plan—it's funded and controlled by the employer, and pays a monthly income at retirement. (This is different from a defined contribution plan, such as a 401(k).) Even though the employee has to wait until retirement to receive payments, the DBP has value today, and the non-employee spouse is entitled to a share of that value. In most cases, you'll need to hire an actuary – a specially trained financial expert - to calculate the present value of DBPs.
8. Overlooking a Qualified Domestic Relations Order (QDRO). A Qualified Domestic Relations Order (QDRO) is a legal document that reflects how you and your spouse have decided to divide a defined contribution plan (eg., 401(k), 403(b), and 457 plans) or a pension plan. A QDRO also orders the plan administrator to pay the non-employee spouse his or her agreed-upon or court-ordered share. The plan administrator cannot make such payments without a valid QDRO in place. Even if you're dealing with a pension that may not be payable for several years, it's crucial that you get the QDRO in place as part of your divorce, or you may lose important pension rights.
9. Having unrealistic expectations about investment returns. If your spouse is trying to convince you to settle for a certain investment because "It's going to grow at 30 percent per year," you might want to get a professional opinion. That investment might not grow at all, or it may yield negative results. Liquid assets (cash or assets that can be easily converted into cash) may provide more financial security than investments, many of which may be risky. Think twice before accepting investments in lieu of safer, less risky assets.
10. Failing to consider your long-term financial security. If you focus only on the immediate task of splitting assets and getting alimony and child support, without understanding how things might look in 10 or 20 years, you're doing yourself a great disservice. You might want to hire a financial planner to review any proposed settlement agreement (before you sign it) and advise you about the long-term financial consequences.