And How to Avoid Them
Divorce is as much a financial separation as an emotional one. Amid the legal complexities and emotional strain, it is easy for divorcing couples to overlook the long-term financial consequences of their decisions. However, missteps made during the divorce process can negatively impact both parties for years to come.
Here, we highlight some of the most common mistakes divorcing couples make and offer steps to help you avoid them.
Key takeaways
- Financial mistakes during the divorce process have the potential to negatively impact your life for many years.
- Proactive planning can help you avoid financial mistakes as you navigate a divorce.
- A financial advisor who has experience helping clients through the divorce process can provide valuable advice in your best interests.
Mistake #1 – Underestimating your post-divorce living expenses
Many people mistakenly assume their post-divorce expenses will be half of what they were during marriage. In reality, maintaining two separate households often costs significantly more than maintaining one after you factor expenses such as rent or mortgage, utilities and insurance.
Avoid it –To avoid underestimating your post-divorce expenses, review several months of bank and credit card statements to gain a full understanding of your current spending needs. Identify what expenses will likely remain the same, increase or decrease following your divorce. Compare those expenses to your anticipated monthly income to make sure you are able to live within your post-divorce means.
Mistake #2 – Fighting to keep the family home
Staying in your marital home can provide emotional comfort and consistency, especially when you have children. However, it can also be a financial trap. Oftentimes, one party becomes “house poor,” struggling to afford home maintenance, taxes and/or a mortgage on a single income. Plus, in order to keep the house, you may need to give up liquid assets, which may be necessary for maintaining the house.
Avoid it – Carefully analyze the affordability of your home post-divorce. This can be an emotional decision, so work with a financial advisor to gain perspective and neutrality as you weigh the pros and cons of selling versus keeping the home.
Mistake #3 – Overlooking retirement accounts
Retirement accounts are often one of the largest marital assets, but they are frequently mishandled. Some individuals waive their rights to a spouse’s retirement plan in exchange for more liquid assets, but doing so can lead to long-term consequences. For example, you could miss out on significant long-term growth, thanks to the power of compounding interest on tax-deferred assets. And, without those assets, you may need to find other sources of savings to fund your retirement.
Avoid it – Work with your financial advisor to make sure all retirement accounts are disclosed and equally divided. It is important to obtain a qualified domestic relations order (QDRO), which is a court-issued document that governs the transfer of retirement plan assets to an alternate payee without triggering a taxable event.
Mistake #4 – Failing to consider tax implications
Many divorce settlement agreements carry tax consequences. For example, spousal support is no longer tax-deductible for the payer or taxable to the recipient (for post-2019 divorces), and withdrawing retirement funds early can result in taxes and penalties. In addition, tax-deferred assets are not equal in value to non-qualified assets, which is why it is important to consider the tax implications of IRA withdrawals when negotiating.
Avoid it – The best way to minimize your tax exposure during a divorce is by working with a financial advisor and CPA to evaluate the after-tax value of both assets and support payments.
Mistake #5 – Neglecting to update beneficiaries and estate plans
Following a divorce, many individuals forget to update their wills, life insurance policies, powers of attorney and retirement account beneficiaries, sometimes leading to the unintended consequence of the ex-spouse inheriting assets.
Avoid it – Once your divorce is final, be sure to update all estate planning documents and beneficiary designations to reflect your current wishes.
Mistake #6 – Hiding assets or failing to disclose debts
It can be a costly mistake to forget to include certain debts or try to hide assets in your divorce negotiations. Courts frown upon it, and it can result in an expensive legal battle as well as significant financial penalties.
Avoid it – Be fully transparent in providing all financial disclosures. Your attorney and financial advisor can help you compile a complete list of all assets and liabilities.
Mistake #7 – Making emotional decisions instead of financial ones
Going through a divorce can be an emotional and trying period of life. It is easy to make decisions based on guilt, revenge or emotion. However, doing so can lead to poor outcomes, such as receiving too little, giving up too much or rushing into final agreements without conducting the necessary due diligence.
Avoid it – Treat your divorce like a business transaction. Rely on trusted professionals, such as your financial advisor, attorney and mediator, as these professionals can guide you with logic and strategy and help you avoid emotional decision-making.
Divorce can be a difficult transition, but careful financial planning and the guidance of trusted professionals can help you avoid mistakes. If you could use some help navigating the financial challenges of a divorce, we would love to have a conversation. To learn more, please contact us.
