281-505-8177
CONTACT US

SCHEDULE A
FREE CONSULTATION

Contact Us: 281-505-8177

Divorce Strategies Group

Denise French

Dividing Property

Options for Dealing with Debt in a Divorce

By

Whether you have a career or are a stay-at-home mom, debt complicates a divorce. Nobody wants to be responsible for paying a spouse’s debts, and you want to avoid having any joint obligations on your side. There is a way forward if you are aware of your options.

Keeping the Debt

You have a few credit cards that you share with your spouse. When you look into your spouses’ spending, you discover that they have used credit cards for all kinds of things you don’t: gambling, alcohol, and a few hotel visits that have nothing to do with business trips.

This naturally is frustrating, so you don’t want to take care of the bill. They’re the other spouse’s expenses and they should have to take care of it, but they are not. The bills don’t get paid and time is moving forward and because the credit cards are under your name, whose credit is getting ruined? Yours.

You want to take care of any joint debt like this, so your credit report is clean. You will be compensated for it in the settlement by getting more of the cash, house, 401K, investments, or asset. Until that happens, you must protect yourself and keep paying the credit cards.

Excessive Spending

If your spouse is spending thousands of dollars you did not approve, we call that a “waste claim.” These can be difficult to prove and you will need attorneys to help.

In one case, the husband had bought a BMW and an apartment for his girlfriend. We found proof of that spending through receipts that amounted to tens of thousands of dollars. Our waste claim proved that he was stealing from the estate and he had to compensate the estate. With the help of a financial professional and the lawyer, he paid that claim on the estate spreadsheet and the wife was given more in assets as a result.

Digging for Information

If you know your spouse has spent a lot of money, but you do not know exactly how much or where there are ways to find this data. For our clients, we do a lot of digging, starting with the accounts we know about and looking for fishy transactions, such as massage parlors, prostitutes, or rent in New York when you don’t own property in New York. We look for anomalous patterns, flag them and ask for more information. We look at property records, tax records, and all kinds of paper. If the spouse isn’t forthcoming, your attorney can subpoena what we need.

Years ago we had a client with a special need’s child. The husband would not pay for future horseback riding for their child with Down’s Syndrome which had proved to be very helpful for the child in the past. He said they did not have any money. Through five-year-old tax records and pieces of paper that our client had been collecting for month, we discovered two rental homes, a girlfriend, and $200,000 in Certificates of Deposit.

If you think your spouse is stealing or hiding money, collect any kind of information, no matter how old or small, and bring it in for us to look at.

Want to know more about what to do? Please contact Divorce Strategies Group for a complimentary consultation. We’ll talk to you about next steps so you can receive the assets which are rightfully yours!

What is a QDRO?

By

A Qualified Domestic Relations Order (or QDRO, pronounced “qua-dro”), is a judicial order in the United States, entered as part of a property division in a divorce which divides a retirement plan or pension plan by recognizing joint marital ownership interests in the plan, specifically the former spouse’s interest in that spouse’s share of the asset.

QDROs apply only to employee benefit or pension plans subject to the Employee Retirement Income Security Act (ERISA), the American federal law governing private sector pensions. Domestic Relations Orders or DRO’s divide military retirement pay and Federal civil service retirement plans. A QDRO or DRO may provide for marital or community property division between the plan participant (the employee or former employee) and the alternate payee (the spouse of the employee or former employee). IRA’s, Roth IRA’s and SEP IRA’s are not subject to ERISA and therefore are not divided typically with a QDRO but rather paperwork from the issuing company.

QDROs and DROs must first be issued by a State-level domestic relations court. The QDRO or DRO is a separate document in addition to your divorce decree. It must be signed by both parties in the divorce as well as their respective attorney’s and the court. Once it is signed by all parties, the QDRO or DRO then needs to be sent to the company’s plan administrator. It must meet the standards of the plan to which it applies. Each company or issuing entity will have their own wording for QDROs and DROs.

Generally, you must have a separate QDRO or DRO for each plan. Each retirement plan is governed by different rules depending on the plan type (i.e. 401(k), Pension Plan, 403(b)). Each QDRO or DRO must be tailored to the requirements of each plan.

The timeline for receiving your awarded funds from a QDRO or DRO is approximately 90 days. We highly encourage you to request the QDRO/DRO process begin as soon as you have completed the mediation process or a decision on the estate has been determined. It is common for a QDRO/DRO to be sent for pre-approval. This is where he QDRO/DRO is completed but not signed, instead it completed with the plan participants information and the divorce decision as far as division is sent to the administrator for pre-approval. This process takes approximately 30 days. Once pre-approval is completed, you know your QDRO/DRO will be approved. We then encourage you to have the QDRO/DRO submitted in conjunction with your divorce decree. This tends to speed up the process and prevents the frustrating delays we have seen multiple times.

If you are in the midst of or finishing up divorce negotiations, we encourage you to schedule a complimentary 30-minute consultation to discuss your situation. We can potentially help you avoid costly delays and frustrations in the QDRO process.

Divorce Myth Busters

By

When going through a divorce, everyone seems to have an opinion – your mother, your father, your aunt, your cousin, your brother’s uncles’ friend, your dog, and anyone else who happens to find out you are getting a divorce. You will likely hear a lot of stories, thoughts, ideas and no doubt myths. In addition, proclamations of how things “always are” or “never are” can be terribly scary. In a time when you’re already going through a lot, you don’t need more stress on your plate.  There are five main divorce myths we have seen with our clients over the years.  This article will discuss the 5 top divorce myths we see and clarify the truth about each one.

Divorce Myth #1:  I don’t need specialized financial divorce support; my estate is simple.

The Truth: It will save you time and money to hire a divorce focused financial professional.

When discussing divorce, finances will always come into play with attorneys and clients. The attorney will be faced with some sort of estate, even if a negative estate, to value and divide.  Some attorneys are very experienced and adept with financials but even those attorneys, at some point, usually suggest the client consult with a financial expert or advisor.  The logical conclusion is to call on the current financial advisor or accountant for ‘free’ advice. However, few accountants, CPA’s or financial advisors in general deal in divorce on a regular basis, so they don’t have the training to handle divorce questions nor do they understand how the divorce realm works.  This really causes problems when dividing retirement accounts and pension plans (two things we do most often) because these professionals don’t understand the complete picture of how everything works together.  Nor do they, in general, understand tracing, separate property, community property or business valuation in regard to divorce laws.  Even worse, we have seen clients frustrated in mediation when the reality of the situation is far different than what the regular financial advisor suggested or stated was needed.  For example, one well-meaning financial advisor told his client she would be okay as long as she received 70% of the estate.  In mediation, 50% of the estate was on the table which brought her a great deal of distress, additional attorney’s fees, the input of a financial divorce related expert and a second mediation. She spent an extra $5,000 just because her well-meaning regular financial advisor steered her in the wrong direction at the onset of the divorce.

We have heard many clients tell us their estate is simple and question their attorneys’ request to hire us.  Your simple estate starts with a house, a mortgage, a 401(k) and maybe a few cars.  Seems simple right?  Well, it is, until it’s not.  Do you need money out of the 401(k)? Do you know the rules surrounding getting your money from a spouse’s 401(k), how it works, the process, the penalties and the tax implications? Oh, and then you forgot there is also a pension, there was that account you inherited a few years ago which you put into a joint account, and that rental property you own.  So, a seemingly simple estate which still had financial issues specific to divorce turns into a very complex estate where separate property tracing comes into play.  We see this all the time!

Even with truly simple estates, there are divorce issues to work through.  You want to keep the home – well, who is on the mortgage? Does the party leaving need to buy a new home?  Did you know there are specific rules around how long you are paid child support before the support can be considered income for a new home purchase? Do you know negotiating spousal support can help you in income calculations for rental properties or for buying a new home?  Do you know how to keep your credit from being ruined in the divorce or what will ruin your credit?  Are you aware of how to time your credit hits with loans you will no doubt need when you buy a new house, a new car, apply for a new job or even rent an apartment?

All of these things a divorce focused financial professional will know (and more), but other financial professionals or advisers who do not work in the divorce realm may not consider or even know to think about.  This could cost you thousands of dollars – well more than you are going to pay a divorce focused financial advisor for basic guidance throughout your divorce.

Divorce Myth #2: Mediation costs too much, it’s not worth it.

The Truth: Mediation is a place where you can be in control and ask for resolutions specific to your family.

Mediation is going to be required by the court (in most Texas counties).  You may have one mediation for temporary orders when the parties will decide how much support is paid, who will keep the children and when, what rules to follow, etc. during the pendency of the divorce.  Then another mediation may be requested for a final orders mediation.  Mediation can be your friend – this is where creative negotiations can occur, and the parties can each work through a solution which is a win-win for everyone.

We hear many clients complain about the cost of sitting in mediation all day or the fear having to deal with their spouse in the course of mediation.  We have seen mediation – even paying for your 2 attorneys’ and an attorney mediator and a financial expert – is well worth the cost!! This is the space where you are in control. A well-crafted mediation day will be attended with a plan – what is your starting point, what is your line in the sand, what is it you really want, how can you negotiate from a position of power, etc.  Further, what do you think your spouse really wants in the divorce and how can you give that to your spouse while you get what you want as well?  Mediation is also a place to receive things like longer term spousal support or a disproportionate share of the estate in lieu of something else.  Mediation is your friend in divorce negotiations.

Divorce Myth #3: It’s too expensive to work with a divorce financial advisor.

The Truth: From a cost perspective, a lot of the work we do will save people thousands of dollars.

From a fee perspective, lawyers and attorneys bill by the hour. If they have to research anything, guide you through what they need from you, or wait while you fumble around in a jumble of papers, that time will get tacked onto the bill.    So, from just helping clients get organized and pull together all the documentation they need to have ready before they see their lawyer, you’ll see a benefit of working with a divorce financial advisor. Together, we are able to gather things efficiently and use your time and money with your attorney wisely.  Further, some attorneys will ask a financial expert or advisor to help them create the community estate and value the estate.  The divorce financial expert often has fees which are far less than the attorney.  The attorney asks us to help the client prepare a marital inventory, asks us which items to request in discovery – and we do all of this at a lower rate.  Because we only do the finances, it is our niche and we are usually pretty proficient at it (which means it takes us less time and costs you less money overall).

Then, there are taxes, debt-related interests, dividing pensions, investments, and retirement accounts in addition to executive compensation plans, stock units, stock options or whole life plans attorneys don’t always know the best way to handle. You could be leaving money on the table with how things are divided if you do not have the proper financial guidance.  When I work with clients, I am able to see the best way to help them gain more financial independence and, bluntly, get or save more money in their divorce.   Often, people are afraid to take on additional costs around a divorce, but there are so many financial considerations you don’t know or aren’t aware of which a divorce focused financial advisor can help you with.

One great example is a divorce we acted as the financial expert in.  Our total fees for the divorce was $5,000.  In the process, we saved the client $60,000 in tax savings between the brokerage accounts, the timing of the divorce year end and the claiming of children in just one year!  It was a huge success for the client with the cost a fraction of the real, cash value savings we provided.

Divorce Myth #4: Divorce has to be horrific and awful.

The Truth: Divorce will be upsetting, emotional and stressful, but it does not have to be the worst experience of your life draining your soul.

Knowledge is power.  We encourage all divorce litigants to become educated on the process, the mandates and their rights.  We offer Wise Woman’s Guide to Divorce and Wise Guy’s Guide to Divorce education workshops just to educate those beginning or in the midst of the divorce process.  This is critical!  When you know what you are facing, you may not feel so lost and in the dark which should help you as you navigate the process.

Additionally, every situation is unique. If someone had a hard divorce, it is because of their individual circumstances.  We encourage those in the divorce process to not listen to others who had horrific experiences.  It reminds me of when I was pregnant and women (sometimes strangers) felt the need to tell me their worst, most horrific birthing stories.  Really – I didn’t need that.  You don’t need it now.    Polite pass on the divorce horror stories and educate your self so you have a more informed divorce path from a position of power and strength.

Divorce Myth #5: I can’t afford a therapist.

The Truth: Having a specialist who is trained to help you sort through your emotions will benefit you both now and in the long run.

While I am not qualified to give you therapeutic advice, I can absolutely encourage you to seek out a therapist to support you during this time. A good therapist can help you sort out your feelings and explore any mental and/or emotional impacts this time may have for you.   In addition, a therapist is a great ally to help you sort through the emotions in a safe place so you can negotiate from fact, not from feeling in the mediation or the negotiation room.

Having a therapist as a specialist for your mental and emotional health makes sense.   As mentioned, running up the bill when you’re disorganized because you’re only working with an attorney and not a financial expert as well, you’re also going to incur more hourly billing.  The same is true if you use your attorney as your therapist.  Let your attorney do what they do best and hire someone else to support you where they are going to make the most impact. You will save yourself money and sanity.

Next Steps

It’s okay (and perfectly natural) if you used to believe these divorce myths. A lot of clients come to us with these questions and more. If you’re wondering the best path for you to take, schedule a complimentary call so we can bust some of your divorce myths and help you come to a more peaceful solution to your divorce.    Call us for a complimentary consultation to discuss your specific needs today.

Dividing Annuity Assets in Divorce

By

Dividing community property, or property jointly owned by a married couple, can often be a complicated process, with your financial options dictated by potential tax implications. While some things may be easy to divide, others are not. Some belongings are sentimental, while others — such as annuities — involve complicated financial calculations. Annuities not only involve moving ownership from one person to the other or joint title to single title, they often also involve moving or potentially deleting critical living benefits, guarantees and/or death benefits as well as surrender penalties on top of potential tax liabilities. That is a lot! Annuities in divorce are complex to say the least. We will attempt to unravel the complexities of annuities as they relate to divorce or at least guide you on what questions to ask.

Annuity Phase

While there are multiple types of annuities (fixed, fixed index, variable, immediate and deferred) all types of annuities are typically in either the accumulation phase or the distribution phase. The different phases will determine how value and divide the annuity in a divorce situation.

Accumulation Phase

If an annuity is in the accumulation phase, it is growing. The annuity may be growing by a simple fixed rate – aka a fixed annuity or by a variety of factors in the fixed index or variable space. The key take-away is there is only growth in this phase. Income has not yet started. This is a critical factor in divorce negotiations. In the accumulation phase the annuity can have three main parts – the actual cash value, the guaranteed benefit amount and the death benefit.

Cash Value

This is the actual cash value. This is real money and should be the value on the marital inventory. This value may have a surrender charge affiliated with it which should also be reflected on the marital inventory. If you do not see a surrender charge on the statement, it is wise to call the carrier and confirm no surrender fee exists. Also, if the contract is still under surrender charge penalties, ask the carrier if they will waive the surrender charge in the case of a divorce where the account is divided between the spouses. We have found quite often they do not waive any fees even though the division is pursuant to a divorce.

Guaranteed Value or Living Benefit Amount

In the accumulation phase, this is the living benefit amount. Many contracts offer a certain amount of guaranteed growth for future income. For example, some annuities may guarantee 7% growth, compounded annually with possibly even a high-water mark (meaning the annuity will capture the highest day of market gains in the annuity contract that year plus add the 7% guaranteed growth on top of this value). Sound too good to be true? What is the catch? This amount is not real money – it cannot be withdrawal in a lump sum. It is the value for which a future income stream is derived. In our same example, let’s say the contract grows by 7% guaranteed compounded annually, and when the client is age 65 a 5% income stream can be taken, guaranteed for life off the 7% compounded number. (In some cases, the income stream will also double for long term care needs for a certain amount of time.) In divorce, the guaranteed amount is often erased if the annuity is divided. This can cost the overall estate hundreds of thousands of dollars.

Know if there is a living benefit and if so, what happens if the annuity is divided between the spouses? The living benefit number is often quite higher than the actual account value, but this is not the number to be listed on the marital inventory. It is a phantom number used to derive a set amount of income at a future date. However, because there is an account value it is the actual cash value which is listed on the estate spreadsheet. The annuities are designed to deplete the cash value over time when the income begins if you live long enough, so this number is not listed on the inventory when the annuity is still in the accumulation phase.

Death Benefit

Sometimes annuities have stand alone death benefits or death benefits attached to the living benefits. This means a certain amount is guaranteed at the death of the annuitant. In some cases, the death benefit is the reason an annuity is sold as life insurance was not an option or was too expensive. It is important to know if an enhanced death benefit exists and if so, know this and other relevant facts. Who is the annuitant? What is the death benefit exactly? What happens in the case of divorce if the contract is divided or moved to the non-annuitant spouse? Now that the couples are divorcing, is the death benefit still relevant or should other options be considered? The death benefit should be on the latest annuity contract statement. However, it is not listed as an asset on the marital inventory as it will only be pain in the event of the annuitant’s death.

Income Phase

If an annuity is in the income phase, it is in distribution. The distribution may be a systematic withdrawal stream on a guaranteed basis, a systematic withdrawal on a non-guaranteed basis or annuitized. This set of facts is vital to know in the case of a divorce.

Systematic Withdrawal – Guaranteed Basis

This should be the most common situation with an annuity. The income from the living benefit has been triggered. In the example above, the 5% income stream at age 65 has begun off the 7% compounded annual growth the annuity provided. If this is the case, the annuity may not be divisible without significantly hurting the amount of income the annuity provides on a guaranteed basis. Contact the carrier to determine how, if at all, the annuity can be divided, and the income stream kept intact. The income stream however may be divisible. The division of this works much like a pension on the estate spreadsheet where a net present value of the future income stream is calculated, and this is the number on the marital inventory.

You can also forego a net present value calculation of the income on the marital inventory and split the income 50/50. We recommend contacting the annuity carrier to determine if division can occur at the carrier level so there is little, if any, interaction between the parties. You will also want to ask the annuity carrier what happens if the annuitant dies. The wife may not receive any payout if the annuity is based only on the husband’s life and he dies or vice versa. Some payouts are based on joint life and some are on single life which were determined at the income stream’s inception. It is vital to understand what happens in the event of one spouse’s death.

Systematic Withdrawal – Nonguaranteed Basis

If this is the case, you can likely divide this annuity. It may not be attached to a living benefit guarantee. This is the least likely to exists and rarely seen, but it is a possibility. It is important to call the carrier and determine your options if this set of facts exists with your annuity. The issue will be mainly surrender charge penalties when this annuity is divided if it is still in the penalty period. We would also ask if there are any issues with the annuitant – is it joint annuitant or single annuitant and will this be possible if you change to the spouse who wants the asset or if you divide the contract in half.

Annuitized

If this is the case, the annuity cash value no longer exists – it is only an income stream. Older contracts typically have this. Most newer contracts do not require annuitization because the contract corpus is gone – it belongs to the annuity company. The valuation of this is now just like the valuation of a pension plan. The carrier may have the income based on joint life or single life. They may divide the income in half but when one spouse dies, the income stream may cease for all. The carrier must be contacted to determine what happens at the death of the owner and/or the death of the annuitant. These facts are important to know as they relate to the income stream after one spouse dies. If you do not want to divide the income, one can calculate a Net Present Value of the future income stream as one would a pension and this number should be indicated on the marital inventory as an asset to be offset with other assets.

Owners and Annuitants

Aside from the issues we stated above in valuing and dividing annuities in the accumulation and the income phases, the named owner and named annuitant could alter the course of the annuity division. It is vital to know who the owner is and who the annuitant is (they may not be the same). These set of facts may determine what happens to the contract when this is divided to the non-owner and/or non-annuitant. Some contracts are jointly owned the with joint annuitants or jointly owned with single annuitants – and each carrier can handle dividing these differently. A simple call to the carrier and a discussion with a member of client services advanced team should straighten out these issues, we just want you to know what to ask for.

Summary

We highly encourage you to reach out to a professional who not only understands annuities, but also understands divorce laws in your area. A Certified Divorce Financial Analyst is the perfect person to have on your team if you or your spouse own an annuity and you are walking through a divorce. We at Divorce Strategies Group understand annuities and divorce finance and can help as well. Contact us for your 30-minute free consultation today.

Three Divorce Mistakes to Avoid

By Leave a Comment

When you are facing divorce life can see overwhelming. To make matters worse, in the midst of emotional turmoil you are asked to make life altering financial decisions. This is tough!! We STRONGLY encourage you to hire a divorce team with experts in each area of needed expertise. An experienced, knowledgeable attorney is critical. Next, if you have financial concerns, it makes sense to hire someone to help you with the financial questions and issues in your divorce. A Certified Divorce Financial Analyst or someone trained and experienced specifically in the areas of divorce finance and tax can save you thousands of dollars in your overall settlement.

We have seen many people come into our offices after the divorce details are finalized only to discover they could have done better or they will lose 30% of what they were awarded to taxes. We don’t want this to happen to those still in the divorce process. Be informed! The following are mistakes we see repeatedly when it comes to divorce.

3. The settlement doesn’t take taxes into effect.

If the old saying, “death and taxes are the only sure thing we have in life” holds true, why would you settle divorce negotiations without knowing the tax implications of your settlement. You are going to be taxed, just know what those taxes will be!

What people often find is the tax burden on their half of the marital assets is significantly higher than their spouse’s. This means their “half” of the assets are worth significantly less than they thought! It’s also important to consider when you will be using the assets you were awarded. For example, what’s worth more – $100,000 in an IRA account or $80,000 in a savings account? Well, it depends! What is your tax bracket and how much cash do you need today? If you need cash now, you are better off taking the $80,000 in a savings account. The $100,000 in an IRA is going to have taxes and possibly penalties taken from it so in the end the $100,000 is probably only worth about $65,000 or $75,000. If you don’t need this money for years, the $100,000 in an IRA will probably be better as it will grow tax deferred for many years and will be able to compound on itself quicker than a taxable $80,000 in savings.

2. Pensions are split 50/50 but no one knows what that really means.

Over and over and over I see divorce decrees that order pensions split 50/50 but no one has any idea what will actually happen. When do you start collecting? How much money can you collect when the pension begins? Is there an option to take a lump sum?

Did you inquire about a separate interest Qualified Domestic Relations Order (QDRO) where you can take the funds on your own timeline? Are you subject to your ex-spouses retirement wants or do you have a say in when the funds begin? Will there be a cost of living increase each year? What if you or your spouse dies before you start collecting? Will it still pay you?

Pensions are complex financial tools with variables many do not consider. In addition, the devil is in the details with the pension plans. Know what you are getting and your options!! If you have a pension you really need a financial expert on your team who understands pensions and QDRO’s so you can make informed decisions.

1. The biggest mistake – keeping a house you can’t afford.

As a woman I understand becoming emotionally attached to a home – this is where my kids have grown up and where we made many happy memories. This spot on the stairs or the place by the front door is where we took pictures every year on the first day of school. This is where I want my kids to come home to when they are grown with their own children. I get it!! It’s tough to leave the marital home if you have such strong emotional ties. However, time and time again my older divorcing couples are told by their adult children – don’t stay in the house!! We don’t care. We just want you to be financially healthy and strong.

As a financial expert, the first thing I’m going to ask my divorcees to do is create a monthly budget. What does it cost to live in this house? I have witnessed where one or two years down the road the spouse who “won the house” has run out of cash and realized that they can’t sell a window to put food on the table, they can’t refinance because now they don’t have enough income, and they have no choice but to sell. Further, the selling costs are about 8% of the sale – all of which could have been split 50/50 with a spouse if the house had been sold during the pendency of the divorce.

The sum this up, please realize you don’t know what you don’t know. Bring in the right experts for your divorce to make sure you are smart, you are informed, and you make the best decisions you can with all the information! Don’t go this alone. As we say at Divorce Strategies Group, “You only have one chance to get it right!” Let us help. Call today for a complimentary consultation to discuss your situation and let us help you start on the right path.

Dividing 529 Plans in Divorce

By Leave a Comment

Year after year, you and your spouse have been saving for college through a 529 savings account. Now that divorce is pending, it’s time to think about spending the money you’ve put aside for your children as a co-parent.  Who will be in control of how much is withdrawn and how it’ll be used?  What are the rules?  How do you put this in writing in a way that makes everyone feel secure about using these funds?   How will you handle contributing to the account going forward? Use the following to learn how dividing 529 plans in divorce works and what steps to take going forward.

CONTRIBUTIONS

You can save up to $15,000 per parent in a 529 account or $30,000 total.  Grandparents can also contribute up to $15,000 per person per year. Contributing more than $15,000 per person would need to be reported to the IRS as a gift. However, a 529 account can be “superfunded” with contributions of $75,000 per person or $150,000 per couple—which uses up your federal gift-tax exclusion for 5 years.  So each parent and the grandparents can still contribute a considerable amount to the 529 accounts.

DISTRIBUTIONS

What can you use this money for? Which expenses trigger taxes and penalties? If you do things right, no penalties or federal income tax—and, in many states, no state income tax—will be due on your withdrawals. But learning by trial and error can be costly at tax time, and more importantly, your child could lose out on financial aid if you’re not careful. So learn the ins and outs ahead of time.

Here’s a guide to help you make your 529 savings go as far as possible.

Plan for tax-free withdrawals

Qualified withdrawals are federal income tax-free so long as the total withdrawals for the year don’t exceed your child’s adjusted qualified higher education expenses (QHEEs), discussed in #3 below.   To calculate these, add up tuition and fees, room and board, books and supplies, any school-related special services, and computer costs, and then deduct any costs already covered by tax-free educational assistance. Examples include Pell grants, tax-free scholarships and fellowships, tuition discounts, the Veteran’s Educational Assistance Program and tax-free employer educational assistance programs.

You’ll also need to deduct costs used to claim or Lifetime Learning Credit. The basic rule: You can’t double up tax benefits for the same college expenses.

Know which expenses qualify

When you pay qualified education expenses from a 529 account, your withdrawals are tax- and penalty-free. As of 2019, qualified expenses include tuition expenses for elementary, middle, and high schools (private, public, or religious). Although the money may come from multiple 529 accounts, only $10,000 total can be spent each year per beneficiary on elementary, middle, or high school tuition.

Money saved in a 529 plan can also be used to pay qualified expenses associated with college or other postsecondary training institutions. Eligible schools include any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the US Department of Education.

While funds from a 529 account can be used to pay for expenses required for college, not all expenses qualify. Tuition and fees are considered required expenses and are allowed, but when it comes to room and board, the costs can’t exceed the greater of the following 2 amounts:

  1. The allowance for room and board included in the school’s cost of attendance for federal financial aid calculations
  2. The actual amount charged if the student is living in housing operated by the educational institution

In other words, if your child is planning to live off campus in housing not owned or operated by the college, you can’t claim expenses in excess of the school’s estimates for room and board for attendance there. So it’s important to confirm room and board costs with the school’s financial aid office in advance so you know what to expect. Also, keep in mind that in order for room and board to qualify, your child must be enrolled half time or more.

Textbooks count as an education expense, but only those included on the required reading for the course.  Computers and related equipment and services are considered qualified expenses if they are used primarily by the beneficiary during any of the years that the beneficiary is enrolled at an eligible educational institution. Computer software for sports, games, or hobbies would be excluded unless the software is predominantly educational in nature.

It’s important to keep receipts and make sure that qualified items are purchased separately from nonqualified items. Be careful to avoid expenses that don’t qualify—for example, equipment used primarily for amusement or entertainment doesn’t qualify. These and other lifestyle expenses, like insurance, sports expenses, health club dues, and travel and transportation costs, will have to be funded through other resources. If you’re not sure whether a plan covers a particular college expense, the college’s financial aid office should be able to help.

Check with the school to find out exactly what’s required so you can avoid accidentally taking a nonqualified distribution. If you withdraw money for anything that doesn’t meet the qualified expense criteria, any part of the distribution that is made up of earnings on contributions will be taxed as ordinary income and could incur a 10% federal penalty. However, the penalty may be waived if there are extenuating circumstances, such as the disability or death of the beneficiary, or if the beneficiary receives a scholarship, veteran’s educational assistance, or other nontaxable education payment that isn’t a gift or inheritance.

If a distribution from a 529 plan is later refunded by an eligible educational institution, a recontribution can be made to the 529 plan. The recontribution must be made no more than 60 days after the date of the refund. The recontributed amount cannot exceed the amount of the refund.

Keep good records

Your 529 savings plan administrator will, in most cases, provide an annual statement that reports your contributions and earnings, including the amount you withdrew from the plan. But it’s you, not your program provider, who is responsible for accurately reporting to the IRS. If your withdrawals are equal to or less than your qualified higher education expenses (QHEEs), then your withdrawals including all your earnings are tax-free. If your withdrawals are higher than your QHEE, then taxes, and potentially a penalty, will be due on earnings that exceed your qualified expenses. For many people, keeping track is easy because large tuition bills use up most of their 529 savings. But if you are using your 529 plan for room and board expenses, it’s smart to keep those receipts.

When divorced, you’ll need to find a way to make sure the IRS receives the correct information. You’ll either need to work together with your spouse each year on what expenses each of you will turn into the IRS or you’ll want one only spouse to handle a particular child’s education costs and reporting needs.

Decide how to withdraw the funds

It’s important that withdrawals you take from your 529 savings account match the payment of qualifying expenses in the same tax year. Like some families, you may choose to pay the school directly from your 529 account for ease in recordkeeping and matching distributions to school expenses. In this situation, make sure you are aware of school payment deadlines and the time required to transfer funds from the 529 account to the school. It can take several days for investments to be sold out of your 529 account and mailed to the school and then a week or so for the payment to make it through the mail and then processed by the school.

Or you may choose to move money from your 529 account to your bank or brokerage account. Many colleges prefer payments to be made electronically through their website from a bank or brokerage account. You can choose to pay bills first and then reimburse yourself from the 529 account, or you can pull money from the 529 account and then use it to pay bills from your bank or brokerage account. This path also provides flexibility when paying smaller bills like those for books or off-campus room and board.

Keep in mind that you must submit your request for the cash within the same calendar year—not the same academic year—as you make the payment. If the timing is off, you risk owing tax because it’s considered a nonqualified withdrawal.

Prioritize which 529 accounts to spend from first

If your child has more than one 529 savings account, such as an additional account through a divorced co-parent or a grandparent, knowing which account to use first or how to take advantage of them concurrently could help. Don’t leave decisions to the last minute—instead, sit down with all plan owners and decide on a withdrawal strategy ahead of time to make sure the qualifying college costs are divvied up in the most beneficial way.

Also, if financial aid is in the picture, a distribution from a grandparent-owned 529 account may be considered income to the child on the next financial aid application, which could significantly affect aid. To avoid any problems, grandparents can take distributions from 529s as early as the spring of the student’s sophomore year—right after the last tax year on the student’s last undergraduate Free Application for Federal Student Aid (FAFSA), assuming the student finishes college within 4 years. Wait until the following spring to employ this strategy if it looks like your child will take 5 years to graduate.

Money left over in your 529 plan?

With careful planning, you can avoid having money left over in your 529 account once your child graduates. But if funds remain, there are several options available. You can let the money sit in the account in anticipation of your child continuing on to graduate school or another post-secondary institution. If so, you’ll want to rethink your investment strategy depending on how soon the funds will be needed so you can take full advantage of the potential for growth over time.

You also have the ability to change beneficiaries without incurring tax consequences. Here are 2 different options for maintaining your tax advantage and avoiding any penalty:

  1. Change the designated beneficiary to another member of the original beneficiary’s family. IRS Publication 970 has a lengthy list detailing which relatives count as family.  This can be done for any reason, but is an option particularly if your child receives a scholarship or decides not to attend college.
  2. Roll over funds from the 529 account to the 529 plan of one of your other children of the marriage without penalty. This is a good option if there are funds left over after graduation.

Either way, we encourage you to draft in your divorce decree what you will do if your children don’t use all of the 529 account funds.  Each child has until the age of 30 to use the funds.  At that point, you can either withdraw the funds and gift it to the child or the parents can divide the remaining funds 50/50 at the end of the time period.

Regardless of which option you choose, you will want to spell it out in your divorce decree today.  Also, each state has different restrictions on 529 accounts, so check with your financial advisor or ask your plan provider for the specific requirements of your plan.

What if the beneficiary gets a scholarship?

You’ll be happy to learn that there is a scholarship exception to the 10% penalty. You can take a nonqualified withdrawal from a 529 account up to the amount of a scholarship; although you will pay taxes on the earnings, you won’t pay the additional 10% penalty that’s imposed on a nonqualified withdrawal. Remember to ask for a scholarship receipt for your tax records.

Consider how college savings affect student aid and loans

While individual colleges may treat assets held in a 529 plan differently, in general these assets have a relatively small effect on federal financial aid eligibility. Because 529 plan assets are considered assets of the parent, they tend to have a small effect when the government calculates your financial aid eligibility, whereas accounts that are considered assets of the child, such as an UGMA or UTMA account, tend to have a greater effect on federal financial aid eligibility. (This does not affect 529 accounts that are owned by a grandparent.) For more information, read about financial aid planning.

If you’re thinking of taking out loans that start incurring interest immediately, you may want to spend 529 funds first, deferring these loans until later. Another situation that would call for using 529 plan funds first would be if there’s a chance your child may graduate earlier or receive some other funding down the road, such as a scholarship.

Create a Plan for Dividing 529 Plans in Divorce

At some point, you’ll actually need to start spending the money you’ve set aside. You will need to think about preserving gains you may have made so that funds will be there when they’re needed. If your plan relies on an age-based investment strategy, this process is already in place and your asset mix has slowly evolved toward more conservative investments like money market funds and short-term bonds.

Now’s the time to sit down with your divorce team and decide the best ways of dividing 529 plans in divorce, how to use these funds and who will be in control of the funds going forward.  The more you decide today, the less you have to decide in the future when the safety of your divorce attorney in negotiations with your spouse is gone.