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Financial Concerns of a Divorce

Updated on August 1, 2012

Divorce Planning

The process of a divorce from your spouse can be a traumatic experience on both of you as well as your children. It can be particularly traumatic to your personal finances. In far too many cases the divorce attorneys are the only ones who reap any major rewards as the two spouse’s battle to the last detail while emotions run high. Whether it is a bitter separation or a more amicable agreement at some point you need to pick up the pieces and move forward with your life. The financial pieces are important to understand in terms of how the details of your agreement can affect your tax and retirement plans.

Alimony

If there is a settlement for alimony involved, the individual whom is required to pay alimony is entitled to a tax deduction on the amount paid to their former spouse. The recipient is required to declare this alimony as taxable income annually. If you are receiving alimony and simultaneously employed, it may be a good idea to discuss with your tax advisor the thought of making quarterly estimated tax payments to the IRS to increase your tax withholding. Otherwise you may have a surprise tax payment due at year end. The tax code on these issues can differ from state to state, so be sure your tax advisor addresses the state code with you.

Child Support

Child support is not a tax deductible item, nor is it taxable income to the recipient of the payments. Again, be aware of any provisions within your state that may apply a different tax law.

Claiming Dependents

Typically if the divorce decree names you as the custodian of the children then you have the ability to claim them as dependents on your income tax return. In the cases where there has been no stipulation, you can typically claim yourself the custodial parent of the child and make them a dependent if they reside with you for the majority of the calendar year. Who claims the child on their income tax can be particularly useful when it comes time to apply for things such as financial aid for college. In many cases where there is a disparity of income, it may benefit the child if they parent with the lower income is declared the custodial parent. In some cases, individual educational institutions will look at both incomes in terms of dispersing endowment funds regardless of the parental arrangement. This is often school specific and should be considered when looking at universities to attend.

Retirement Plans

In many cases a spouse may have been allocated a sizeable portion of the other spouse’s retirement plan as part of a Qualified Domestic Relations Order (QDRO). The QDRO in such cases is not taxable to the recipient. They simply transfer the tax sheltered retirement account into another IRA/401k in their name. The same rules apply as if the account originated with the recipient. You will have access to the account at normal retirement age of 55 in a 401k & 59 1/2 in an IRA. Taxes will only be due upon distribution of the plan to you as income. Distributions taken prior to normal retirement age will result in income taxes as well as an additional 10% penalty.

Investments & Cash Positions

Pursuant to a divorce settlement, you can typically transfer assets between spouses with tax free transfers. Items such as Gift Tax filings typically do not apply. Be sure that once a settlement is reached that all beneficiary data is updated. Regardless of what your divorce degree or your will says, if you left an ex-spouse as a beneficiary to your IRA that will supersede all other documentation.

Primary Residence

This is an area that many times is a source of controversy in a divorce. One spouse feels they want the house enough to forfeit other assets in return. In some cases the individual receiving the residence was not the primary earner and did not typically account for the finances in the home. In such cases before you insist on this asset in a long drawn out dispute, sit down and itemize some expenses. Account for both essential and discretionary expenses. Make sure this is a property that you can afford to or at least want to afford to maintain. In some cases even with the alimony it may not be viable regardless of how much you love the home. Often times it may make sense to simply sell the home and equally downsize.

Social Security

Social Security allows at retirement one of two possible benefits. Either you receive your stated benefit tied to your personal earnings, or you are entitled to 50% of your spouse’s benefit at full retirement. Essentially you will receive the higher of the two options. In cases of divorced couples, if you were married for at least 10 years you will be entitled to the same spousal benefits as though you were never divorced. The only thing that would disqualify this would be if you were re-married prior to SS eligibility. However, if you re-married after you reached eligibility and already began collecting, this would not impact your SS benefits.

Significant Business Assets

In cases where there may be non-liquid assets or even an interest in a family enterprise your attorney should retain the services of an individual valuation specialist to properly value the asset. In many small businesses this can be complicated as a result of the many tax deductions small business owners are entitled to receive. In cases were the separation can get contentious, it is not uncommon for one party with a small business that tends to deal in cash to not report all of their income. It may be something that has been happening for some time and not just begun as the relationship went sour. In such a situation your attorney will likely need to retain the services of a forensic accountant that can re-create the lifestyle you spouse is or was living, and what the necessary cash flow the business would have had to produce to support this lifestyle. At times the fear of a forensic analysis may induce the counterparty to be a bit more cooperative.

Clearly we’d all prefer to have to avoid this type of event. However in cases where it is unavoidable, it’s best to try and mediate these issues in a rational and amicable way. If that can’t be done, the legal cost to both parties will likely be substantial. And many divorce attorneys would like nothing more than to see a contentious separation that will produce sizeable billing hours. Try your best to make un-emotional and rational financial decisions.


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    • LandmarkWealth profile image
      Author

      LandmarkWealth 5 years ago from Melville NY

      Thanks, Hopefully you never have to deal with it.

    • Bruce Clark profile image

      Bruce Clark 5 years ago

      The area in finances is quite a struggling part more especially when you are in full custody of your children and you don't earn that much from work. It's definitely a headache, but the tips you've mentioned above makes a difference along the divorce journey. Thanks for the information.