Negotiating your separation agreement can be one of the most trying, costly, and long-lasting events in your lifetime. Just like our transition to springtime, a change in attitude and mindset can enhance your chances of a faster and financially positive divorce settlement.
To be better informed and able to make the tough decisions that come along in the process, take a step back and avoid these common mistakes.
1. Assuming your divorce will be fast and not costly
Depending upon your selection of a divorce attorney or mediator, the amount of assets at stake, the amiability of the partners, etc., your divorce can cost more money and take longer to settle than you may think. For most couples, the whole process can take one to two years. The cost can range from several hundred dollars to several thousand, even if you do not go to court (which can cost at least $25,000 plus for each spouse).
At first blush, splitting the family financial pie would appear to be a fairly simple task. An equitable property division, consistent with the respective spouse’s divorce rights would lead you to believe that each partner would walk away with half of what was shared by two.
This mathematical formula does not consistently work in divorce. Spouses have unequal salaries and income potential. Many times, families live beyond their means; there may not be enough money to go around. These factors, along with the typical “hanging on to each dollar” can lengthen the process, which leads to additional time and mounting costs.
2. Selling out your future
Your final decisions concerning which assets you are keeping will have an impact on your immediate future and long-term goals. What are the hidden expenses (maintenance, income taxes, etc.) of the assets you may want? Will you have enough money to pay your bills? What financial assets will you have to face unexpected costs and meet long-term goals (e.g. college costs, retirement, etc.)?
Trading away long-term options (e.g. retirement accounts) for short-term needs (desires) may not be in your best interest and may lead you to sacrifice tomorrow for what you may want today.
3. Ignoring Income Taxes
Income taxes will affect most of the major financial aspects of the divorce settlement. Generally speaking, the transfer of property pursuant to a divorce is a nontaxable event. But that changes if you subsequently sell the property. At that time, you will be solely responsible for paying the tax on all of the gain (profit) earned from the time you and your spouse originally purchased it.
Consider carefully how you will file you tax returns while you are in the process of creating a separation agreement. Although there are non-financial considerations, the Married Filing Separate filing status normally yields the highest overall tax rate. Filing Head of Household normally produces the least amount of tax.
You will also want to review the tax implications of alimony and child support, dependency exemptions, and various tax credits that are associated with the custody of the child.
4. Not protecting your financial interests
Maybe you have been married for 10, 15, 20 years or more. It is difficult to think about separate accounts or removing your spouse’s name from charge cards. The reality is that you are at risk any time you hold a joint interest in, or have responsibility with, or are financially dependent upon your ex-spouse.
What happens in the future if your former spouse defaults on payments becomes disabled, goes bankrupt, or dies? You should consider these possibilities that could have a significant impact on your financial position and take appropriate measures to protect your interest (and that of your children).
5. Not recognizing “A bird in hand…”
You may have to weigh decisions like this: What do you want, the Lexus worth $35,000 or the mutual fund worth $30,000? Do you want lifetime payments that begin at age 65 (or if and when your spouse retires) or $300,000 today?
Keep the phase in mind, “a bird in the hand is worth two in the bush.” In divorce situations, this axiom usually holds true. Let’s take a look at the Lexus. Sure it may be worth $35,000 now, but what will it be worth next year? If you really need cash, how much could it be sold for? The mutual fund is liquid now, will most likely increase in value, and provides a cushion for those unexpected expenses.
What about retirement income? It sounds secure, but you may have to wait 20 or 30 years to receive the payments. It may be wiser to take the cash now, make prudent investment decisions, and build your own retirement nest egg.
In my experience, it is difficult for divorcing partners to see beyond the day in front of them. Avoiding these mistakes by obtaining the divorce advice of a Certified Divorce Financial Analyst can help you maintain your financial status and minimize the risk of financial loss.