After years of working with divorcing clients, I’ve compiled what I believe are the top 10 most critical financial errors in divorce. These are all errors I’ve seen with our own clients or my associates’ clients. These are all items that can be avoided with property knowledge and preparation.
1. Not filing the necessary forms to receive your awarded IRA’s or retirement plans.
This is one of the top financial errors in divorce. When the divorce proceedings are wrapping up, the parties tend to relax and think all is over and taken care of. In my experience, that is not necessarily true. Now, the work to move the awarded assets must begin or better yet, is already in process and follow up must take place. I’ve seen clients go back to court to receive awarded IRA’s when paperwork was not in good order. I’ve also seen much stress over 401k assets when QDRO’s were not properly prepared and filed originally.
Here are a few tips to avoid these kinds of issues:
- Get required signatures on IRA’s that you are awarded before the divorce is finalized or at finalization, while the attorneys are still involved. It is very likely there is a form the firm will require which must be signed by the relinquishing party when you are awarded an IRA. It’s best to do this while the divorce is still in process and lawyers are still involved. Make sure all or any investment company signature guarantees are completed properly as well.
- Have employee retirement plan QDRO’s completed prior to finalizing the divorce and have them available for the judge’s signature when the divorce is filed. Check with your attorney on what time line the court requires – some only honor the QDRO’s for 30 days after finalization of the divorce without requiring additional signed forms by your ex-spouse.
- Ask your attorney what deeds need to be created and signed for hard assets you are receiving. Make sure you are your attorney agree on the time line for creating or filling any necessary deeds for properties – especially those awarded to you.
2. Not following up on real property needs or understanding real property issues after divorce.
I recently received a call from a woman whose husband was awarded the house during their divorce. However, since they did a “kitchen table” divorce and did not involve attorney’s or financial professionals, there was no discussion of what happens if the husband did not make the monthly mortgage payments. In their current situation, the husband was three months behind, the wife was still on the mortgage watching her credit fall and was powerless to change. She could have had protection put in place from an attorney setting up special deeds to protect her – but she didn’t know to do this.
- Make sure you speak to an attorney about deeds if you are transferring property ownership from both spouses to one spouse. Do this before you finalize the divorce.
- Speak to mortgage specialists about re-financing the mortgage prior to finalizing the divorce.
3. Being unaware of tax recapture rules
For the duration of 2018, spouses can receive a tax break for spousal support or alimony payments.
Under Internal Revenue Code (IRC) § 71, recapture requirements apply if excess alimony payments are front-loaded into the first three post-separation years. Their purpose is to discourage divorcing spouses from improperly characterizing property settlement payments as alimony.
Recapture would also apply for spousal support being reduced around the time a child or children turn the age of majority including: if spousal support payments are reduced or terminated within 6 months before or after the date a child attains the local age of majority, or when payments are reduced within a year before or after two individual children of the payor attain a certain age between 18 and 24, if payments are reduced upon each child turning the same age.
If child support payments are ceased with any of these two events, the payments would have been presumed to be associated with a child-related contingency and the IRS could have re-characterized spousal support payments as child support for the entire period.
- To avoid recapture concerns I use a calculator if the support will be reduced the first three years.
- To avoid the recapture for contingencies related the children, I look very closely at the calendar comparing when the payments will stop versus when the children turn 18, 21 and 24.
4. Ignoring tax ramifications of different types of accounts and ignoring basis information.
If you are receiving any asset, make sure you understand the tax consequence of moving that asset into cash. The final amounts you receive from a $100,000 IRA, a $100,000 401k pursuant to divorce, a $100,000 CD, a $100,000 annuity and a $100,000 Roth IRA are vastly different. Also, you need to know the cost basis which is the original principal amount invested, and any additional investments made. If you do not know this then you may have more tax liability than necessary. You don’t typically owe tax on the cost basis – just on the growth of that basis.
- Ask your attorney or mediator to require the spouse relinquishing the asset to provide cost basis information by a certain date and in a certain format. It is usually by date of divorce and in writing.
5. Forgetting about the Spousal Survivor Benefit
I have seen financial errors in divorce cases where both husband and wife were retired and receiving pensions pre-divorce and wanted to keep it that way post-divorce. No big deal, right? No QDROs needed. That might be true, but did anyone think about the spousal survivor benefit? Can the election be undone? Certainly the husband and wife may want to stop paying the premium on that election. And if either took a joint and survivor option at in retirement, can they now “pop-up” to a single life annuity option post-divorce? Both attorneys and clients sometimes overlook these considerations. To be safe, I look at the payouts options of each client. If they are joint and survivor, I check the rules to see if that could change in the future. If it can be changed, this needs to be discussed and evaluated prior to divorce proceedings being finalized.
6. Executive Compensation Plans Not Split Correctly
I’ve found account taxation is often ignored or forgotten as the divorce is closer to being finalized. Often attorney’s and clients understand the 401k has tax ramifications, but the tax consequence of stock plans sales or other executive compensation plans are often ignored in divorce. I’ve also noticed that attorney’s often do not delineate what is required to be reported and by which spouse.
These accounts may not always be able to be divided. You must check with the company prior to division.
The cost basis needs to be disclosed on stock plans and other executive benefit plans if they are divisible.
7. Overlooking Pension Plan Assets
I had a client whose husband had always handled the couple’s finances which lead to one of the worst financial errors in divorce. I asked her to send me everything she could find regarding their assets; buried deep in the 120 pages in a box was her husband’s pension statement. His pension had two parts: a monthly income stream and a supplemental benefit that had a present value of $930,000. The $90,000 was included in the husband’s disclosure document, but he made no mention of the monthly pension income. I valued that income at around $890,000 and included it in the asset division report to my client and her attorney.
The number on the pension statement is not usually the real value of the pension. This is often incorrectly valued in divorce negotiations.
8. Failing to Advise Clients to Refinance the Mortgage Beforethe Divorce is Final
Let’s say that John and Jane have agreed that John will keep the family home post-divorce, giving Jane other assets to make up for her share of the current equity. You can do quitclaims to change the titling of the home, but unless John refinances the original joint mortgage, Jane is still financially responsible for the mortgage. If John stops making mortgage payments, it will affect Jane’s credit report as though she had missed the payments herself. The only way to ensure this doesn’t happen is for John to refinance that mortgage before the divorce is final.
What I suggest in these cases are:
- Refinance the home in the person’s name who is receiving the home prior to the divorce being final or at the very least have time lines on when the refinance must happen and consequences if the refinance does not happen (as in the other spouse keeps the home)
- If there is no way to refinance the home, then a deed of trust to secure assumption can be created to protect the person who no longer owns the home but is still on the mortgage. I would ask an attorney about the details of this and get their advice if this should be necessary.
9. Not understanding debt and divorce
I have a client who came to me for help, but had already discussed splitting everything down the middle with her spouse. They had already decided that was how they were going to split their estate. However, they had more debt than assets and the debts were all in the wife’s name alone. The husband could not qualify for debt in his name alone which was one of the financial errors in divorce I saw. They each had their own pension plans – plans with a future income stream from their respective companies, but no cash value today.
The wife did not understand that the debt in her name was her responsibility, ultimately, and a divorce decree did not change this. To be careful I always check to see who’s name the debt is in via the statement. I usually give each person the debt in their name to them. In this case, there are not enough assets to cover the debts so spousal maintenance or a buy out payment plan will have to be created to pay off the marital portion of debt to the wife, or she will have to take her husband’s pension plan.
10. Failing to Get the Insurance Before Signing the Settlement
The insured should go through the underwriting process prior to signing the settlement agreement to avoid financial errors in divorce. If coverage will not be available due to health issues, or if the premiums are prohibitively expensive, other provisions should be included in the settlement to protect against pre-mature death, such as the creation of trusts or other estate-planning tools.