Your Investing Life: Getting divorced
October 31, 2013
Ending a marriage can be tough, no matter how it happens. Dealing with the emotional impact is hard enough.
In addition, you've got to sort out the financial and investing implications for yourself and your children, if you have them. Here are some sensible steps that can help you cope with some of the financial considerations of getting divorced.
Get expert help
The thought of expensive legal and consulting bills might make you think of trying to economize on the attorney you hire or even going it alone. Don't. You need a financially savvy expert who'll be your advocate. A professional attorney or advisor (or even a team if it makes sense) specializing in divorce can help smooth the process of dividing assets and, if appropriate, determining support payments. It can also help you maintain some needed emotional distance.
"You often hear 'Think of the financial part of your divorce as a business transaction.' It's good advice, but it's hard to do," said Karin Risi, who heads Vanguard Advice Services. "I know from personal experience just how tough it can be—and I'm a financial professional."
Depending on how complex your financial situation may be—maybe you and your soon-to-be-ex own a business together or have substantial marital assets—you may want to consider engaging a financial planner who can help you sort out the alphabet soup of acronyms, from IRAs (Individual Retirement Arrangements) to QDROs (Qualified Domestic Relations Orders).
Deal with documentation
Paperwork (or its electronic equivalent) comes with the territory when you're performing most financial transactions. Here are a few key documentation actions to keep in mind as you go through the divorce process:
- Qualified Domestic Relations Order (QDRO) to divide pension or other employer retirement accounts. This document orders the plan administrator to pay the non-employee spouse the portion laid out by a court order or settlement agreement. Many states have their own laws and requirements around QDRO preparation and filing, so make sure to check those for your state.
- Change of ownership forms to divide retirement assets not in an employer plan, as well as taxable accounts as appropriate. A court may order that IRA and other assets be divided. (Vanguard has a change of ownership document package available online.)
- Social Security documentation to file for spousal benefits. If you were married 10 years or more to a spouse who paid into the system, you may qualify to receive spousal benefits from Social Security.
- Beneficiary designations for your financial accounts and insurance policies. If your former spouse was among your beneficiaries, you may want to update these documents.
- Financial and medical power of attorney forms. It's a good idea to have paperwork in place authorizing someone you trust to make medical and financial decisions for you if you're unable to do so, especially once your divorce is final and your former spouse is no longer considered next of kin.
- Will, estate executor, and related documents. Having estate plan documents in place can help ensure that your wishes are carried out when the time comes. Also, if you marry again, these documents can help clear up confusion about what portion of your assets (if any) your previous spouse should receive versus your current spouse.
- Title changes for any things, including vehicles and real estate, previously held jointly. If one of you retains ownership, you'll need to make this change. A note of caution about real estate: Often the marital home is the largest asset a couple has and determining its custody can be contentious, thanks to the emotional grip it holds. But it may make more sense for your financial future to sell the home, avoid the burden of taxes and maintenance costs, and protect your finances.
"Having the right documents in place can make things easier for you going forward," said Chuck Riley, a financial planner with Vanguard Advice Services. "For example, it can be complicated—and costly—to try and have an ex-spouse removed from your will once the document comes into play."
Mr. Riley shared a friend's unfortunate experience about how continuing to hold a mortgage jointly, instead of putting the house and loan in the spouse's name hurt her credit rating. Because both names remained on the mortgage, she was liable for the mortgage payments he failed to make after assuming "custody" of the home. "Selling the home might seem like a difficult option, perhaps financially and often emotionally. But it might be the right one, so both parties can get a fresh start on their lives," he said.
Negotiate for your needs
Take inventory of your expenses and financial needs before you head into any asset division discussions, suggested Alisa Shin, a senior wealth planner with Vanguard Asset Management Services™. That information can help support your requests during the settlement process.
Also, when you're negotiating the asset split, "pay attention to the types of assets you're agreeing to take—how liquid they are and their tax implications. You want to be careful before you agree to anything, so you're sure you're getting your fair share," Ms. Shin said.
Invest for your future
Once you receive your agreed-upon or court-designated share of marital assets, you can get down to planning and investing for your future.
One of Vanguard's core principles for investing success is to have an appropriate balance of stocks and bonds, called your asset allocation, for your goals, time when you need the money you're investing (your time horizon), and your comfort with risk.
If you received a substantial sum after the division of assets is complete, you might be drawn to the idea of keeping those assets in cash or highly liquid holding. But avoiding any risk in investing could expose you to something called shortfall risk. As Ms. Risi said, "If your holdings are too conservative for your time horizon, you run the risk of losing pace with inflation and outliving your assets."
If you're unsure about how to determine your asset allocation, our Investor Questionnaire can help you. Or consider a target date fund, such as the Vanguard Target Retirement Fund series; these funds are broadly diversified and managed by professionals who adjust the investment's risk profile to become more conservative over time.
Insure against the unexpected
Insurance is something you never want to use—but are glad you have when you need it. Have your health insurance coverage in place before your divorce is final, especially if you were on your spouse's plan.
"Once you're no longer married, you can't stay covered by your former spouse's health insurance plan," said Amy Vogt, a financial planner with Vanguard Asset Management Services. If you're working and your employer offers a health plan, you should be able to join it without too much effort because your divorce is considered a major life event. If you have children, you'll have to work out with your former spouse which one of you will insure them.
Explore disability insurance as well—for yourself and your former spouse. Your former spouse having this kind of coverage is especially important if you're going to receive child support or alimony payments. It's okay for you to ask your spouse to obtain this coverage and have the appropriate designations in place for you to receive payments as appropriate. Be prepared for the possibility that you may have to go back to court to enforce this right, though.
You'll likely also need your own auto and homeowners' insurance policies. If you downsize to a smaller home or vehicle or decide to up your deductible, you may be able to save some money on coverage.
One more form of "insurance" is an emergency fund with at least 6-12 months' living expenses. "It's like an insurance policy you create for yourself, to ensure you have the money you need for an expense, when you need it," Mr. Riley said. If that amount seems overwhelming, start with a goal of building up a $1,000 cash cushion, and then adding to it as you can.
Investigate tax implications
There are numerous possible tax implications when you divorce and divide marital assets. The most noticeable one is your tax-filing status. After the first year your divorce is complete, you'll no longer file as "married, filing jointly" on your federal tax returns. (It may still be appropriate for you to file jointly with your former spouse in the tax year your divorce is finalized.)
Some other tax implications to consider:
- Selling property, including your home, can cause you to owe capital gains taxes. The good news is that, if you lived in the home for two of the last five years and owned it at least that long, you (and your former spouse) qualify for a one-time $250,000 exemption. If you don't meet those conditions, you may qualify for a reduced exclusion, depending on how long you owned and lived in the home.
- Liquidating retirement savings, rather than transferring them, can result in what's called a taxable distribution. Unless you're over age 59½, you'll be subject to paying income tax, plus a 10% federal tax penalty. (Our IRA comparison page can help you see the tax implications—and benefits—of both traditional and Roth IRAs.)
- Selling investments can also trigger capital gains taxes. You can save on these taxes through asset transfers, which are tax-free.
- Claiming dependent children on tax returns hinges on which person is the custodial parent. Generally, whoever gets the kids gets the deductions and credits, too. The custodial parent can sign a waiver allowing the noncustodial parent who's paying child support to take these credits and deductions. Also, the noncustodial parent can continue to write off children's medical expenses that parent pays, if certain thresholds are met. It's a good idea to formalize these arrangements in your divorce decree or agreement to head off any disagreements in the future.
- You can take a tax deduction for any alimony payments you make, even if you don't itemize. If you're receiving alimony payments, you'll have to pay income taxes on them.
- Child support isn't considered income; if you receive it, you won't owe taxes on it. If you're paying it, you won't be able to deduct it, either.
In particular, Mr. Riley cautioned against tapping into retirement savings to meet your demand for cash in a divorce. "Avoid it unless it's absolutely your last resort because of the tax penalties," he said. "Even if you take a hardship withdrawal from your account, you'll still have to pay the 10% penalty if you're under the age 59½ threshold."
Your divorce may be final, but, as the saying goes, life goes on. By taking a few simple steps, you'll be better prepared for the financial tasks ahead and ready to embark on a new beginning.
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against loss in a declining market.
- Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
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