Advice from a Divorce Financial Planner, Costly Mistakes to Avoid in a Divorce

By Nicole Young on March 31, 2022

Unfortunately, roughly half of all marriages end in divorce. Before you contact an attorney, familiarize yourself with these costly mistakes we have seen. You may want to talk with a financial advisor who focuses on working with family law attorneys and their clients to educate and empower them about their finances. Having the right professionals on your divorce team is imperative to you achieving the best outcome possible.

Complex Income Structures

Determining a financial settlement incorporating splitting of assets, maintenance, and child support — while certainly not easy — can be straightforward, in part because many of these splits are driven by formulas. Attorneys work within these formulas and guidelines every day; they know where there is wiggle room and where a judge will not give. However, the situation is different when one of the spouses has a compensation structure that is more complex than a salary and cash bonus. This applies to business owners, equity partners of professional services firms and high-level executives. It is common they have many components of their compensation:

• Base salary
• Cash bonuses
• Co-Investments (Equity stakes underlying investments)
• Stock incentives (Private or Public)
• Deferred compensation plans
• Retirement plan contributions and matches
• International assets
• Complex trusts

Often their income exceeds the income cap for straight forward use of the guidelines. This is a situation for which the involvement of a financial advisor who understands these types of compensation arrangements can be helpful by working with your attorney to understand the liquidity and tax consequences.  

In addition to having a financial advisor who is knowledgeable in this area on your divorce team, understanding the type of attorney that will best serve you and your family is key. Not only for the attorney you hire but the one that your spouse hires as well. This will play into your strategy and approach for the divorce process.  

Private Investments

Private investments are a broad category. Here are some common examples:

• One-off investments to family and friends
• Direct investments into companies
• Residential or commercial real estate
• Private equity or hedge funds

There are nuances to these investments which bring them beyond the straightforward (i.e., you can’t simply ask for an up-to-date account statement like you might for a bank or brokerage account). It is important to gather a detailed inventory of these investments.

Almost always, these investments have stale valuations and/or are difficult to value; if valued incorrectly, you are losing out on a source of income for which you were part of the initial investment. Likewise, they can be difficult to split, so there is discussion involved in who takes what—and what do you get in lieu of the investment. In addition, you might be subject to asymmetrical information regarding these types of investments; your spouse may say “that’s not worth anything” and you may not know any better, so agree. In addition to the valuation, you will need a list of outstanding capital calls and an understanding of any distributions.

Having an initial list of what you believe is out there is a good starting point for discussion with your attorney.

Some spouses think that they can simply transfer their valuable assets to a third party such as a business partner or child from a former marriage. These kinds of transfers can, and usually are, seen as fraudulent, thus impacting one of the most important factors in a courtroom: trust and credibility. if you believe you are in a situation that one partner is hiding assets, you will need the assistance of an attorney and the experienced professionals they would recommend. Forensic accountants can help uncover hidden assets, business evaluators can assess commercial holdings and vocational experts can help determine whether support should be awarded to a non-working spouse.

Business Owners

Spouses who are business owners warrant special attention. The spouse who is not the owner is at a disadvantage in being able to properly value the current and prospects of the business; there is a natural incentive for the owner to undervalue the company. Many times, depending on the nature and size of the business, a business appraisal will be needed.  If you are litigating your divorce, it is common that each side will have an appraisal done.

And not all businesses are created equal. For instance, is a consulting business with no assets other than the owner’s contacts and relationships of no worth? That’s a difficult argument for the owner to make if he or she has been generating an income on which the family depended; valuing such a business might consider long-term contracts, past revenues, and a myriad of other factors.

Once a valuation is agreed upon, what to do with it still poses many challenges. It may not be feasible to simply split the business down the middle with the owner paying out half the value if it will cripple the ongoing success of that business. It’s also rarely advisable for ex-spouses to continue to act as co-owners of the business.

Retirement Accounts

Because of tax implications, splitting retirement accounts isn’t as simple as adding up the totals and dividing in half. In some cases, couples choose to use retirement accounts as an offset for another asset — i.e., keeping a retirement account whole and offsetting that by forfeiting a share of the family home. When they are split, it is done by qualified domestic relations order (QDRO), which is an evaluation of the assets, a split of said assets, and payment of one share to the other party’s retirement account without triggering tax consequences.

Oftentimes, splitting retirement accounts by QDRO can take a significant amount of time to be fully transitioned to the other spouse’s name.  During this time, the market is still open and trading daily.  If the verbiage of the QDRO, and ultimately what gets submitted to the plan administrator for processing, does not incorporate market return, you could leave a lot of money on the table. 

In dealing with QDRO’s, the goal should be to resolve the QDRO during the court process while everyone is motivated to work together for an overall resolution. The QDRO submission process becomes more complex as time goes by with various changes that may occur that could impact the benefits awarded such as market gains/losses, employment changes, unexpected life changes such as death, or even remarriage that impacts beneficiary status and survivor benefits.

Lastly, if you are taking a retirement asset and your partner is taking a taxable asset, you have to account for the difference in taxes and liquidity.  A retirement account is generally not liquid unless you are 59.5 or older and can avoid the 10% penalty.  Even then, every dollar from a retirement account (unless it is a Roth vehicle) is taxed as ordinary income.  For example, $500k in a 401(k) is more like0 $350k; assuming 30% in taxes.  

Additional Financial Considerations

Keeping the Primary Home — The Importance of a Plan

Often, women want to stay in their pre-divorce home, particularly when there are children involved. There’s a lot of upheavals and moving only adds to a chaotic situation. It is important to account for all expenses related to maintaining the home. This includes the mortgage (if applicable), real estate taxes, insurance, regular and one-off repairs, and maintenance. If one spouse needs to be removed from the mortgage or a buy out is part of your asset division, ensure that you work with a mortgage broker who is familiar with the lending guidelines around divorce, early in the process. You don’t want to find out after the divorce is final that the agreement cannot be executed.

If you choose to keep the house and do not understand how it impacts your overall financial picture, it can lead to negative consequences over the long term. For example, if the homeowner needs to consistently dip into savings to cover expenses. If the only source of savings is retirement, the homeowner can get hit with penalties and taxes on each withdrawal, making it a very expensive source of funding. Furthermore, gambling against the future to pay for immediate expenses is not a good long-term OR short-term strategy. Beyond that, homes are also traditionally not a highly appreciating asset. All the sacrifice to stay in the home can come at the cost of keeping an asset that might not serve the owner as well as other assets would have, leading to fewer assets in retirement.

As mentioned previously, one consideration could be one spouse keeping the greater share

of a retirement account while the other gets the house outright; another scenario is the spouse who retains the house also takes on an additional financial burden, such as sole responsibility for paying for college for the children of the marriage.

All these plans are also impacted by tax considerations. The tax bracket may change for both spouses shifting the amount owed. While maintenance and child support are tax neutral, many assets have embedded tax consequences. These are good conversations to have with a financial advisor skilled in this specific space — one who understands all the emotional and financial considerations involved in these important financial decisions. This is a time to look at creating a financial plan and budget; looking at pros and cons and priorities to determine the best course forward financially and realistically. There may be alternatives that are more than numbers on paper, and a financial advisor who works with divorcing couples likely has seen any number of mutually successful outcomes.

Health Care

Most of the time one spouse is going to need to get new healthcare after a separation and certainly after the divorce (in some cases, separated couples can stay on one healthcare plan) because they will need to come off the other’s health care coverage. Premium cost and prescription costs can be shockingly expensive, especially if the spouse who needs insurance does not have options through an employer.  Pre-existing conditions can also add an additional layer of planning. Be sure to include the premium, prescription, and other costs of covering your and your children’s ongoing healthcare needs. In some cases, even if one spouse maintains the coverage for children, out-of-pocket costs are still split (arrangements should be made to formalize payment structure for those costs). It’s an additional financial consideration that should not be overlooked in reaching a settlement as it can lead to additional financial stress if not planned for upfront.

Capital Losses on Tax Returns

In this case, we are talking about a hidden gem often overlooked from prior tax returns. The provision allows whoever retains the rights, per the divorce agreement, to offset future gains. Here’s an example: the couple realized a $200k capital loss in 2019 — then divorced. In 2020, there is a $300k gain. The spouse who kept the loss will only pay taxes on $100k of this gain. If the loss is not retained, the tax will be paid on the full $300k gain. The point? Financial settlements are rarely straightforward and a financial advisor who knows what to look for can often make a significant impact in a very short time.

Emotional Impact

One of the last things that are important to consider is the emotions that are inevitable in working through a divorce — these emotions can often lead to mistakes that cannot be reversed.

In some cases, one spouse may be feeling guilty; often, that spouse tends to give more than they should (i.e., a spouse entitled to maintenance waives all claims; a spouse with lucrative premarital assets agrees to give those non-marital assets to the other spouse).

Another emotion-charged issue: a rush to leave the marriage. Several things can push this feeling — perhaps you think you’d give anything to get away from your spouse (note — in some cases, both spouses may stay in the marital home until the divorce is final — that may exacerbate this feeling). Maybe you’ve fallen in love with someone else and feel the need to speed up this process to start a new life. But agreeing to terms such as non-required maintenance, or division of assets and liabilities just to get away from a person or just to be with someone else, can have devastating effects on you financially short and long term. Settling an additional amount beyond what is “required” for children’s welfare is one thing; settling too much just to escape shouldn’t be a driver.

How do you “escape the emotions”? When it comes to money, think of a divorce as the equivalent to the dissolution of a business. Decisions should not be made on emotions or without sound and objective professional advice. Working with an attorney and a financial advisor, collaboratively, means that your interests are protected so you can focus on your emotional well-being and long-term financial success. Contact Private Vista to help you avoid costly mistakes in your divorce.

Article By: Nicole Romito CFP®, CDFA™: Nicole is a Partner and Lead Advisor at Private Vista LLC. Nicole built her entire career in the financial services industry as a trusted partner and sounding board for clients. Nicole helps them manage their emotions around their wealth so they can tune out the noise that might get in the way of making financial decisions that are right for them and their loved ones. She focuses on working with women in transition — divorce, widowed or retiring senior executives. She feels that it is extremely gratifying to see clients flourish as they move from a place of feeling overwhelmed and frightened to one of confidence and clarity.