When “We Do” Becomes “We Don’t Anymore:” Planning Considerations For Divorce

Divorce is one of the most stressful events in life, commonly ranked alongside the death of a loved one, moving, job loss, and long-term illness. Divorce is mentally and emotionally draining; ironing out a divorce settlement, attending various court hearings, and dealing with competing attorneys can all weigh heavily on the parties involved.

In addition to the emotional toll, it’s essential to understand how divorce can impact your financial position. If you and your partner have decided to get a divorce, ensuring that your finances are on the right track is essential. You will then be able to put the past behind you and set in place the building blocks that can be the foundation for your new financial future.

Assess Your Financial Situation

During the divorce process, both spouses must determine and disclose their monthly income and expense needs. This financial affidavit supports claims (based on need and an evaluation of the other party’s ability to pay).

Every couple has its way of bookkeeping; in some instances, one spouse assumes primary responsibility for the family budget, and for others, bills are paid when due, but neither party sticks to a budget. No matter what situation you’re exiting, cash will inevitably become tighter as two new households are created during and after divorce. Creating and sticking to a budget can make life easier.

Remember, you may need to cut back on some of your discretionary spending until you adjust to living on less income. It’s important not to deprive yourself entirely of any enjoyment, however. Build the occasional reward (yoga classes, dinner with friends, whatever you choose) into your budget.

While adjusting to your new budget, control your debt and credit. Avoid the temptation to rely on credit cards to provide extras. If you do have credit card debt, try to put a plan in place to pay it off as quickly as possible.

Since divorce can hurt your credit rating, consider protecting your credit record or establishing credit in your name. A favorable credit history is essential since it will allow you to obtain credit when needed and at a lower interest rate. Employers even sometimes view good credit as a prerequisite for employment. Review your credit report and check it for any inaccuracies. To establish a good track record with creditors, make your monthly bill payments on time and avoid having too many credit inquiries on your report.

Tax Considerations

If you’re separated or divorced, you must become familiar with specific tax issues. Familiarity with the tax consequences of your financial and personal decisions might cause you to alter your plans in some areas.

Your filing status is important because it determines, in part, the deductions and credits available to you, the amount of standard deduction that you may be entitled to, and your correct amount of tax. Therefore, you should know which filing statuses are available and which will best fit your needs. Whether you’re considered married or unmarried is less apparent than it may seem. It depends on several rules and your legal status as of the last day of the tax year (December 31 for most individuals).

If you’re separated or considering a divorce, you and your spouse might wish to continue filing your tax returns jointly for as long as possible. If this is the case, you should know the advantages and disadvantages of this filing status. Pay close attention to the impact of joint filing on your right to all or a portion of any tax refunds and how your spouse’s liabilities may affect you. For example, signing a joint return obligates you and your spouse to be jointly and severally liable for any errors (intentional or otherwise) on your tax return.

Division of interest and dividends on jointly held assets must be discussed, as should the deduction for real estate taxes paid and the allocation of tax carryovers. The tax effects of property dispositions can vary greatly, depending on whether you decide to transfer property immediately to your spouse, sell the property to a third party, or sell it to your spouse at some future point.

If you (or your spouse) have a retirement plan, you should understand a qualified domestic relations order (QDRO) and whether it applies. You should also know the income tax ramifications when retirement plans are divided according to a court order.

(Note that for divorces finalized after December 31, 2018, alimony/spousal support payments are no longer deductible by the payor.)

Risk Management

Typically, insurance coverage for one or both spouses is negotiated as part of a divorce settlement. However, you may have additional insurance needs beyond what you can obtain through your divorce settlement.

When it comes to health insurance, make having adequate coverage a priority. Unless your divorce settlement requires your spouse to provide you with health coverage, one option is to obtain temporary health insurance coverage (up to 36
months) through the Consolidated Omnibus Budget Reconciliation Act (COBRA). You can also look into purchasing individual coverage or, if employed, coverage through your employer.

Additionally, you’ll want to ensure that your disability and life insurance coverage matches your current needs. This is especially true if you are reentering the workforce or if you’re the custodial parent of your children.

Finally, make sure that your property insurance coverage is updated. Any applicable property insurance policies may need to be modified or rewritten to reflect property ownership changes resulting from your divorce.

Estate Planning

When divorce is contemplated, the selection of beneficiaries and legal representatives will likely be revised to reflect the absence of your former spouse. You should make the necessary changes in your will or other estate planning documents to ensure that your former spouse isn’t named as your representative, successor trustee, beneficiary, or holder of the power of attorney.

(Note that in some states, wills drawn up during a marriage are considered void after a divorce unless expressly ratified after the divorce. This means that intestacy rules would apply instead of the will being controlling.)

Additionally, you will need to re-examine your estate plan’s gift and estate tax aspects. Consider gift tax implications if funding your children’s education is required by your property settlement. Although your direct tuition payments (even for adult children) are exempt from gift tax when required by a property settlement agreement, be aware that your payments for related educational expenses (e.g., books and room and board) may be subject to gift tax.

Furthermore, consider the absence of the unlimited marital deduction. A deduction is allowed for qualifying transfers to
one’s spouse during a lifetime or at death. Because this gift and estate tax deduction is one of the most critical estate planning tools for married couples, losing this tool at divorce can adversely affect your tax situation when you die.

Conclusion

There’s simply no simple way to end a marriage. Divorce is challenging, at best. Getting your trusted team of advisors in place to help you navigate a divorce is critical to getting through it. Contact a Sequoia Financial Group advisor to help you successfully build for your new future.