How To Navigate Your Finances When Going Through a Divorce
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In today’s column, we chat with Dina Friedman, a managing director and wealth strategist at Merrill Private Wealth Management, about the common mistakes women make when navigating a divorce and how to ensure you’re best prepared for the financial transition from “ours” to “yours” and “mine.”
Don’t Neglect To Review Planning Documents and Beneficiary Designations
“Part of going through the process of divorce is all the financial ramifications of that,” Friedman said. “People typically focus on the assets and income, but they won’t necessarily look at what the implications are of different types of trusts that have been put into place, or assets that have beneficiary designations that have long-term implications.”
Friedman said that trusts, in particular, are often neglected when a couple figures out their divorce agreement.
“Frequently, families have quite a lot of assets in these irrevocable trusts. Now what happens when someone gets divorced?” Friedman said. “If it’s a trust that’s for the benefit of the spouse, that spouse may now be divorced from the person who created that trust, and may or may not still have a continuing interest in that trust depending on what is actually in the language of the trust itself.”
According to Friedman, “matrimonial lawyers are very good at assessing assets, but they’re not necessarily as good at reviewing these other types of very complicated legal documents, like trusts.”
But neglecting to review trusts may lead to an inequitable division of assets. It’s important to “evaluate those [documents] within the holistic context of all of the assets that might be available post-divorce,” Friedman said.
In addition to trusts, it’s important to review beneficiary designations in the context of insurance policies and retirement plans.
“Again, those aren’t necessarily part of what we would call ‘equitable distribution,’ which is taking all of the assets that the couple has and dividing them in some way,” Friedman said. “But the beneficiary designations on insurance policies and retirement plans are very important. They have to be evaluated at the time of divorce. [When you] move assets between the couple when they’re getting divorced, you don’t have any tax implications to that — you can move those assets without triggering capital gains tax, without triggering the gift tax — but if a couple gets divorced and you find a mistake five years later, it’s not as easy to do that. Then you’ve got a bigger problem, because now if you want to rearrange the assets between the two people who are no longer married, you’re going to have all these other potential income tax issues.”
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Pay Attention To All of the Financial Implications of a Proposed Settlement
Before agreeing to any divorce settlement — even one that seems fair on paper — take into account all of the various nuances that may affect your finances.
“Part of what we do is we look at different settlement proposals from the perspective of, if this is what you’re paid out, how does that actually translate into income that you could use to support yourself for, and for how long?” Friedman notes.
One of the elements that should be taken into consideration is whether you agree to a lump sum payout or a payout over time.
“A lump sum is potentially more valuable than a payout over time, where you’re essentially giving your former spouse an interest-free loan,” Friedman said. “And with a long-term payout, you’re also taking on business risk. Maybe what you’re getting today is what [your spouse’s] business is worth, but what if it goes bankrupt?”
Women also need to take liquidity into consideration when dividing up assets.
“When couples are dividing assets and one says, ‘I would just like the $1 million cash, you take the $1 million vacation home,’ that looks like they’re splitting things equally — but is that really equal when one has cash in hand that they can spend for any purpose, and the other has a home that may potentially be difficult to sell if they had to have that money for something?” Friedman said. “They wouldn’t be able to access that as easily as the person with the cash.”
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In addition, “taxation becomes a very important factor,” Friedman said. “You want to try to minimize any tax disparities between the parties post-divorce with respect to the assets.”
Friedman again gives the example of the $1 million house versus $1 million in cash.
“If it’s sold, is going to be [worth] significantly less than the receipt of sale because whoever owns that home is going to have to pay capital gains tax, whereas if you just take a cash settlement with no admittance, you don’t have that tax,” Friedman said. “Those aren’t really equal, even though they might look equal. Evaluating the embedded taxations and the tax ramifications of different assets is also very important.”
Meet With a Financial Advisor Before Signing on the Dotted Line
“Meeting with a financial advisor before you divorce is as important as meeting with a divorce lawyer,” Friedman said.
This is vital whether you hold the greater income and assets, or whether your spouse was the primary income earner.
“There’s going to have to be some kind of financial planning because you’re taking one household and dividing it into two, so you’re losing some of that economy of scale that you have in a single household,” Friedman said. “Meeting with a financial advisor can help you get a handle on, what is a realistic settlement? What is one I can live with? What is the wish list? [An advisor can help you] develop a financial negotiating position in addition to whatever other issues went on in the marriage.”
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