11 Common Financial Mistakes Made in Divorces
During your marriage, you and your ex most likely comingled funds and budgeted together. These are sound marital practices, but divorce puts you in a position that requires an in-depth review of the income, expenses, and assets that you and your ex brought to the marriage and forces you to make important decisions with lasting implications. Too often people underestimate just how complex these issues can be and how important it is to make the right choices. Your best plan of action is to be informed, take your time, think practically instead of emotionally, and consider the future when getting your divorce finances all in a line.
That being said, we have compiled a list of the most common financial mistakes people make when divorcing, as well as tips on how you can avoid similar pitfalls. While this list may set your mind at ease some, it does not replace the advice of a qualified professional when it comes to unique circumstances of your case. You may still find it necessary to consult a financial expert to assist with your situation.
Not knowing your marital finances
The first step in reaching a fair financial outcome in your divorce is determining where you and your ex-spouse actually stand. This requires a careful review of all income and expenses. You should assess all sources of income that your ex and you make, everything from your salary to investments and benefit plans to get an idea of what your exact divorce finances look like.
Perhaps your ex managed the budget and you were not involved. If this is the case your ex will have an unfair advantage over you when it comes time to settle your divorce finances. Equip yourself with the knowledge of all marital assets and request access to all reports and statements.
Tip: If you suspect your ex has hidden assets or is lying about their finances to avoid having to divide them with you, you should bring this up with your attorney and possibly inform the court. Lying to the court and failing to disclose assets is illegal and could result in your ex being held in contempt of court.
Underestimating your personal monthly spending
You will need to figure out what you personally spend monthly and what your cost of living will be once you are separated. Be careful and make sure to appropriately estimate your personal monthly spending. Your budget must be reasonable and in line with your current standard of living, but you can and should factor in future inflation, future costs, and consider insurance. Your budget becomes the baseline for calculating alimony. It is important to get this calculation correct because if you do not accurately budget, you run the risk of underestimating your future needs, and may end up unable to maintain your quality of life. Inflation is the most common overlooked factor in creating this budget.
Tip: Take your time and write out all of your expenses in a monthly budget. It may be worth consulting with a financial professional to assure your budget is accurate and complete, and to provide you with the best method of calculating inflation and insurance costs.
Not putting aside cash in a separate account to sustain yourself through the divorce process
Between the date of separation and the time it takes to settle a divorce, you could possibly end up in a state of financial uncertainty for months. You should consider putting money away now to provide for yourself during the divorce process. This rainy-day fund is a safety-net for the worst case scenario concerning your divorce finances. Imagine a situation in which you were recently laid-off from your job and your alimony claim is stalled. This could leave you without funds or a source of income for an indefinite period. If you begin saving now, you could have enough to cushion yourself through those hard times.
Tip: Your safety-net is not a secret fund. Hiding money or lying about your assets could cause tension and troubling legal consequences for you during the divorce. When it comes time to report finances for division, be open and honest about all current assets, including your safety-net.
Assuming “equal” division is fair
An asset’s value is not necessarily defined by or limited to its current market value. Additionally, assets that generate income, i.e. rental property or bonds, may be worth more than their “market” value. For example, your house and your 401k are not worth the same, even if you’ve invested the same dollar amounts into them.
Instead of dividing property based on current monetary value, consider the full value of the assets over time in deciding how to split everything “equally”.
Tip: Pay special attention to any associated tax costs, transactional fees, or other hidden expenses that may be attached to an asset.
Wanting to keep the family home even when you can’t afford to
A house is more than another asset, it’s an intimate place with priceless emotional value. However, it is necessary to be realistic and protect yourself from future financial trouble when settling a divorce, and that means making tough decisions. If you cannot afford the family home then you may need to let it go. Homes often have a very low return on investment, sometimes even resulting in negative returns. If you ignore the numbers and attempt to hold on, you could find yourself struggling under the weight of the mortgage, maintenance, and property tax costs.
Tip: Most mistakes made during a divorce stem from actions taken from an emotional perspective. It is hard to separate the emotional weight of your situation from the practical and logistical, but it must be done for your own benefit. Consider the financial decisions of your divorce in the same way you would handle business transactions, supported by numbers, facts, and solid calculations.
Not knowing your ex’s work benefits and stock investments
Your ex’s employer-funded pensions and investments are assets of value that you are entitled to a share of, even if payment does not occur until the employee spouse retires. You should familiarize yourself with all of your ex’s assets and any potential rights you may have regarding these benefits and other divorce finances. Defined benefit plans, 401(k)s, and company stock may all be subject to division between the employee spouse and the non-employee spouse. In most cases, you will need to consult an actuary to calculate the present value of these assets.
Tip: Proceed with caution regarding risky investments and expected returns. Your ex may be attempting to convince you that a certain investment will yield a large enticing profit in an attempt to bargain for a different asset they would prefer to take in the division. In reality there may be no evidence to support your ex’s claimed return on investment. Consult a professional on the risks and potential for all investments before reaching a settlement. If it seems an offer is too good to be true, it very well may be.
Not filing a Qualified Domestic Relations Order (QDRO)
A Qualified Domestic Relations Order (QDRO) is a legal document that reflects how you and your spouse have agreed to divide a defined contribution plan, such as a 401(k), 403(b), 457 plans, or a pension plan.A QDRO also orders the company’s plan administrator to pay the agreed-upon share to the non-employee spouse. The payments cannot be made without a valid QDRO in place. It is crucial that you file a QDRO or you risk losing important rights.
Ignoring the impact of tax liability and penalties From spousal support to withdrawing from retirement accounts, there are several tax implications to consider concerning your divorce finances. You may incur a tax liability on the portion of the marital assets you receive after settling. For example, you need to consider the taxes you will have to pay on withdrawing funds from a retirement plan, and possible penalties if the money is withdrawn early. It could also be beneficial to pay or receive a lump sum distribution instead of alimony in order to avoid income tax implications. . Taxes are a complicated and nuanced subject area. It is worth consulting a qualified professional about any tax implications before you agree to a property division.
From spousal support to withdrawing from retirement accounts, there are several tax implications to consider concerning your divorce finances. You may incur a tax liability on the portion of the marital assets you receive after settling. For example, you need to consider the taxes you will have to pay on withdrawing funds from a retirement plan, and possible penalties if the money is withdrawn early. It could also be beneficial to pay or receive a lump sum distribution instead of alimony in order to avoid income tax implications. . Taxes are a complicated and nuanced subject area. It is worth consulting a qualified professional about any tax implications before you agree to a property division.
Tip: When considering a potential settlement, calculate the after-tax value of investments. An amount may seem appealing at first, but it is only after subtracting the tax liability that you can determine the true value of an asset, what you will actually receive.
Not understanding your responsibility to pay marital debt
In most cases, if a debt was incurred during your marriage, it is a shared liability. Dividing the responsibility for marital debts is part of the divorce process, but debtors often do not abide by the arrangements you and your ex made. Unexpected debts like this could cause complications and unexpected stress in your divorce finances if you are unaware of your liability, or if your ex accepts responsibility yet fails to keep up. Let’s say you agree that your ex will be responsible for the credit card in both of your names but fails to make timely payments. The collection agencies could come after you and won’t simply forgive you because of a divorce settlement agreement.
Tip: If possible, avoid the stress and reduce your risk of being harassed by debtors later by paying off all marital debts before the divorce becomes final.
Not securing enough alimony or child support and failing to insure your alimony
Most people are unaware of just how hard it is to modify an alimony or child support order. You should make sure your alimony and child support terms are comprehensive and clearly stated in your court order or separation agreement, because it won’t be easy to modify later on.
Additionally, if your ex cannot pay for alimony or child support then there will be nothing for you to collect. In the event your ex becomes disabled, deceased, or unemployed, you may be left without any support. You can request that your spouse obtain disability and life insurance policies (or modify an existing policy) to ensure you will continue to receive support in the event of any accident or drastic change in your ex’s circumstances, thus avoiding any impact to your post-divorce finances.
Tip: It may be possible to negotiate the alimony and child support payments to include money to cover the costs of the life insurance policy.
And finally: Choosing the wrong attorney
Your divorce is already a stressful and time-consuming process, especially when it comes to your divorce finances. If you can reduce the cost and burden on yourself it will greatly reduce your stress levels and better equip you for a stable future. An aggressive lawyer may frustrate your ex causing negotiations to turn sour or even hostile. Additionally, an attorney that instigates a fight runs the risk of squandering your share of the marital estate in unnecessary litigation costs and fees. Instead, find a lawyer that will advocate for your best interest in a professional way, and try to leave the emotion out of it.
Tip: Mediation may be your best money-saver. If the relationship with your ex is amicable enough, you could save a lot of time and money by avoiding the court room altogether. Mediation usually involves a neutral third-party family law attorney assisting you in reaching an agreement that works for both parties. This process provides flexibility and efficiency over the traditional court route.
There is certainly a lot to consider here, and it definitely can seem overwhelming. But if you take your time to become informed, consider all the circumstances with the knowledge of your current situation and an eye towards your future, you can avoid these divorce finance mistakes. Remember, try to act from a place of logic and consider finding trustworthy qualified financial professionals to get the best outcome.