The U.S. stock market continues to be a daily surprise — sometimes shock — to investors and businesses across the country. While there’s never a promise of financial gains in the stock market, there are times, such as now, during which anxiety about your financial security is heightened. Divorce is also a time when financial anxieties grow. When the stock market and economy go crazy, you might worry you’d be crazy to pursue a divorce in a volatile market.
Economic fears are understandable, but you can get divorced during a tumultuous market and still come out with your financial security intact. You will just have to be extra careful and strategic during property division negotiations. This is also a critical time to enlist a Certified Divorce Financial Analyst (CDFA) on your divorce team.
Know Type of Accounts and Cost Basis
If you are like many working couples, you have money saved in retirement accounts like an IRA or 401(K) as well as other money invested in the stock market.
A retirement account is also called a qualified account. When you take funds out of an IRA to cash in your bank the money is taxed fully as if you had worked for a company and earned that money. If you are under 59.5 years old you may also be hit with a 10% penalty on IRA accounts taken out in cash. Conversely, if you cash funds out of a 401(k) or other ERISA governed group retirement plan owned by your spouse, you will still be taxed on those funds, but you will not pay the 10% penalty if you take them out pursuant to a divorce and a Qualified Domestic Relations Order or QDRO. This all applies to a cash distribution. Any retirement funds you move into your own IRA will have no tax due.
During volatile markets when the values are low, it will be wise to work with a Certified Divorce Financial Analyst to determine if now is the best time to convert these funds to a Roth IRA. If you do so, you will pay tax now on the lower values but not pay any tax in the future on the growth of the account or distributions from the account years down the road at retirement age. Further you can also use ROTH IRA funds within certain parameters, for a first time home purchase or for education.
The non-retirement accounts are non-qualified accounts. The taxes related to these accounts are handled differently than taxes tied to qualified, retirement accounts. When addressing non-qualified accounts and stocks, pay attention to cost basis. The cost basis of an individual security (stock) is the cost you and/or your spouse paid for it at the beginning. Let’s assume you both decide to split the value of the stocks. You want to look at more than the current value of your investments. You need to know which stocks have increased in value since you bought into them and which have decreased in value. This might sound backwards, but the stocks that have decreased in value compared to their cost basis can be better for your finances in a divorce. Why? Simply because of taxation. If the government sees there’s been a financial loss, you aren’t taxed for that. If you only get the share of stocks that have increased in value, the taxes you pay in capital gains could result in a lower payout for you.
Stock Market Risk Tolerance
Another factor to consider is the experience and comfort of the spouse who originally managed the account versus the spouse who is receiving the account. For example, just because the spouse who traditionally handled the accounts is very aggressive and has a comfort level with stock market risk, the other spouse taking over those funds may not. The accounts may need to be moved into a different set of stocks or other assets for the comfort level of the spouse taking over the stock account, especially in a turbulent market.
We had a client who’s spouse was a financial advisor. He was very comfortable with stock market risk and understood complex investment concepts. His wife had never had to worry about their investments. We took over her account after the divorce and found it was invested in an extremely aggressive S&P 500 2x portfolio which meant it moved like the S&P 500 did, only twice as far. In up markets that is great, they captured double the return of the markets. However, in down markets it would be catastrophic. We moved her into a more conservative portfolio which proved to be very helpful when the markets fell.
The Wording Will Make All the Difference
When dividing divorce assets and debts, the estate will usually be divided as of a certain date. In Texas, you will typically be mandated to attend at least one mediation. When you choose to finalize the details of your estate in mediation, that tends to be the date of division. After mediation, attorneys will draft your divorce decree from the mediated settlement agreement, review it with you and then schedule a date and time to attend court to finalize your divorce. These steps take time. The date of division could be months away from the actual date of divorce (when you can start dividing the assets) which is why the wording in your division is so important.
For those who finalized the division of their estate in mediation in December of 2019 but didn’t get divorced until March of 2020, the wording would be critical. For example, if you had stated you wanted a set amount you would be thrilled because the market losses would not affect you (unless the account became smaller than what you were awarded). Conversely, if you agreed to take 50% of the estate including gains and losses in the account you will participate in the market swings whether up or down.
No matter which option your choose and agree to in mediation, a set dollar amount or a percent of the estate, you will want to understand what you are choosing and have some level of control over the assets in such a volatile market. This should provide peace of mind in knowing roughly what you are getting in your estate settlement. You can also request the funds be put in more conservative investments while the divorce finalization is pending. You do not have to sit in fear throughout this process, you just need to have help from someone who understands how this works.
Divorce in a Volatile Market: Keep Calm and Invest On
It is very common within a marriage for one spouse to control the investment decisions and the other spouse to not. If you were the spouse who did not make investing decisions, you aren’t alone in not fully understanding how the markets and investments work. For many who get divorced, the marriage ends and, suddenly, they are left wondering how to manage a stock portfolio. This new post-divorce reality can lead to anxiety. Worry about affording life after divorce, along with the felt ignorance when faced with the stock market, can result in a knee-jerk financial decisions. Many with less experience running the finances will choose to simply cash out all the stocks they received through the division of assets. Making the decision to cash out from an emotional place may provide some immediate relief; but could really hurt you in the long run. While cash is the best place for an emergency fund and for safety for part of a portfolio in a falling market, it is also the one asset class proven to lose money to inflation over the long term.
A focus on financial planning for the future, however, can be a growth opportunity after divorce, both in the metaphorical sense and in terms of your net worth. The financial markets can be your friend. That may be difficult to believe, particularly at times when stock market volatility is an everyday headline, but the facts are clear: the US stock market is one of the best investments you can make. History of the stock market has shown investing long-term is a strategic way to financially survive, even with volatile markets.
You Don’t Have to be a Financial Expert
When you decide to divorce in a volatile market, you aren’t signing up to become a financial expert. However, it is wise to hire one. During difficult market times it can be very scary but enlisting a Certified Divorce Financial Analyst or CDFA who is well versed in both the details of a divorce financial division and stock markets can be very helpful. Many CDFA’s are experienced financial planners and advisors who have been through their own divorce and understand what you are going through both professionally and personally. These professionals understand the markets and investing. They are also trained to work specifically with divorcing couples and individuals and understand how divorce finance works. These professionals can help you as they only focus on the finances a divorce case, and will work alongside you and your divorce attorney.
If you have questions or concerns about the financials of your divorce, schedule a call or video conference with us today to get the answers you need.