Attorneys say that if both you and your ex-spouse feel like you came out of your divorce thinking you gave up a lot, your settlement was probably fair. Maybe, but often your settlement’s results appear only after you live with them for a while. Here are five settlement pitfalls to watch for.
1. House poor. People don’t like being uprooted and often hesitate to inflict change on children who may already be upset from the divorce. Others are seriously attached to their house and likely invested a lot of work in it over the years. Nevertheless, many of the recently divorced ultimately find house payments difficult and the house itself difficult to maintain alone.
Your house may also suddenly be too large and, depending on the situation, can produce a huge and unexpected taxable event such as capital gains when you sell it.
2. Short-sightedness. All too often divorcing people focus on short-term issues and benefits rather than considering long-term effects of financial decisions. Some are so eager to end the marriage that they don’t even want to discuss the benefits and drawbacks of decisions.
Money decisions amid emotional turmoil almost always come with obvious plusses and hidden, eventual minuses. For example, if you keep the house and the equity but give up some substantially equal amount in a retirement plan account, you risk missing out on investment-return gains in your retirement accounts and lose that amount of savings for your retirement and your future. If you have to refinance the house to pay some of the equity to your spouse, you may run into cash-flow problems – essentially trading retirement savings for, perhaps, equity in a home that you may ultimately find too expensive to keep.
Always consider the long-term and the likely what-ifs.
3. Real costs. Maybe you simply have to keep that rental home. Or maybe you want favorite investments in the settlement. You’re likely looking at the current value of the investment, without considering costs of liquidation.
For example, if you receive the rental home and eventually sell it, you must pay capital gains and depreciation recapture, a sort of past-due for tax breaks you take for wear on the property through years and which can amount to a sizable (up to 25%) tax bite. You may also pay Realtor fees and general sales expenses.
Always calculate the cost of eventually selling or disposing of an asset that’s part of a marital settlement.
4. Payback. The major goal of some divorcing couples seems to be revenge at any cost. These people appear unable to speak civilly to each other, much less able to discuss differences and mediate issues; sometimes they actively work to undermine each other, stall and engage in other bad behavior.
Many not only create a poisonous atmosphere but often ratchet up attorneys’ fees. Family law attorneys often charge more than $350 an hour, may want a $10,000 retainer (renewable when depleted, naturally) and charge you 15 minutes of billable time for reading one short email.
Sometimes attorneys also engage other experts, such as business valuation specialists, pension evaluators, certified public accountants, investigators and career and vocation evaluators, among others. Fees can mount up.
If you’re willing to be reasonable, maybe try mediation. If that fails, at least try to not fan the flames and instead listen to the practical advice of your attorney. Why break the bank?
5. See only one piece. A divorce settlement is often a large puzzle with lots of pieces. People commonly look at one or maybe two areas, not the entire picture.
For example, you and your ex can trade the child exemption on your tax returns in different years. Having a child one extra day a year may allow you to claim head of household status when you file income taxes, potentially a considerable saving. You may also want to receive more maintenance (alimony) and less child support – without realizing that alimony incurs income tax.
To cite another instance, an attorney once asked me about the advisability of a lump sum in lieu of a series of alimony payments. The payer in that case was unable to deduct the lump sum from his income tax because of an arcane rule about front-end loading (excess) alimony; the Internal Revenue Service considers such a payment a non-taxable property settlement and therefore not deductible.
Much like when you decided to divorce in the first place, look at your settlement agreement as a whole. All parts need to work together to help you thrive in the near-term as well as in your future.
Follow AdviceIQ on Twitter at @adviceiq.
Wendy Spencer, CFP, CDFA, is president of Spencer Capital Strategies Inc., an independent Money Concepts contractor in Arvada, Colo. She is also a family law mediator; her divorce website is www.divorcemoneypro.com.
AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.