Financial mistakes in the negotiations of a divorce settlement are sure to be costly to one party or the other. Don't let it be you!
Divorce is an emotional crisis, but it need not be a financial disaster. The key is to understand what is best for you in the long run and not do what seems easiest in the short term. You are about to make financial decisions that will affect the rest of your life. Remember, your divorce attorney is not a financial expert. Further, unforeseen consequences of a financial mistake can take several years to become evident. But when they do, it is real.
I believe that no divorce should happen without the input of a divorce financial professional. To do so is like saying you will have surgery (on your finances) but let's not invite the surgeon. Just let the anesthesiologist, or nurse, or CEO of the hospital do the cutting since they are all highly qualified professionals.
My professional practice is in Tennessee, which ranks among the top states in the nation for divorce rates. It is no mystery to me that we are also the highest ranking state for bankruptcies, divorce being a major factor.
Mistake #1 - The House
The most common, and potentially most damaging, mistake in a divorce settlement is for one of the parties to keep the house. Too often, this is an emotional decision, rather than a financially sound decision. There are many emotional reasons to want to remain in a house: the memories, familiar neighborhood, schools, or it's just comfortable to do so at this time.
I understand. But none of these may make good financial sense and can make you "house poor". That is when you have a lot of house and little else to take to the grocery store.
Remember, you have a house that was selected for two adults, and now there will be one. The house may have required two incomes to support it, and now there will be one. Something smaller may be the better financial decision. Do a thorough analysis of what that house costs including maintenance, taxes, utilities, and other items you may not think about on a daily basis. In addition, you will need to “buy out” your spouse’s share of the equity by either giving up other valuable assets or pulling more value out of the house in a refinance. If you currently have a joint mortgage, or if it is in your spouse’s name, you will need to refinance anyway, but with a “buy out,” the mortgage will be higher. If you are not able to "buy out" your spouse's share of the equity, you will have a more complex form of joint ownership going forward.
Mistake #2 - Future Expenses
Far too often, estimates of future living expenses are just not accurate. It may have been a long time since you had to think about what it will cost one to live. The truth is that two can live almost as cheaply as one. Therefore, two living separately becomes much more expensive all at once. Between the two of you, combined future expenses may go up 20-40%. However, there will be no additional money to cover these expenses, no matter how it is divided. Therefore, unless you are currently living below your means, you should each expect your standard of living to decline somewhat.
Accurate expenses are critical if you will be negotiating spousal support, also known as alimony, no matter which side of those negotiations you will be on. If you anticipate receiving alimony, you will need to know how much you need, otherwise you will not be able to ask for it, then you surely won’t get it. If you anticipate paying alimony, you need to know how much you need for yourself, so you don’t lose it, then it is not there when you need it.
Or, if you have children, child support only goes so far. No one considers that where the kids live, so gather the friends. A few extra teenagers can consume your entire week's groceries in a couple hours. Since child support is awarded according to state guidelines, this is usually not an area open to negotiations. However, you do need to know what it will really cost to live going forward.
Mistake #3 - Impact of Taxes
Tax issues surrounding the financial aspects of divorce are often misunderstood or overlooked. The areas most likely to be of concern are income taxes, capital gains taxes, and the effects of alimony.
Income tax obligations as single individuals (or head of household) will differ. You and your former spouse are likely to be in different tax brackets. Therefore, the terms of nearly every other financial issue may have different values to each of you. Knowing what something is really worth to you, or your spouse, will enable you and your attorney to negotiate better for what you want.
Capital gains taxes may influence the disposition of the house which is subject to a capital gains exemption under proper circumstances. Lack of good planning regarding exactly how and when it is sold could result in a costly mistake. If capital gains had been rolled into the marital home from other house(s) owned before 1997, old tax rules will apply to determine the cost basis of the current house.
Potential tax obligations due on investments, upon future sale, will impact their current value to each of you. For instance, two brokerage accounts having the same monetary balance of $300,000 may not have the same real value if one of them has potential capital gains taxes, which will reduce its net assessment, and the other does not.
Retirement accounts present complex tax considerations with some special exceptions for circumstances of divorce. Funds which are generally not available without penalty, may be accessible within certain limits and procedures.
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